59

STATEMENT OF FRED T. GOLDBERG, JR. PARTNER,
SKADDEN, ARPS, SLATE, MEAGHER & FLOM; AND FORMER
COMMISSIONER, INTERNAL REVENUE SERVICE

Mr. GoLpBERG. Thank you, Madam Chairman, for the oppor-
tunity to appear before you today. I would like to submit my writ-
ten statement for the record. I will keep my remarks brief.

It seems to me the place to start in thinking about the-proposed
1994 TCMP is with what we know. What we know is that it will
cost the government more than $550 million. While there are no
precise measures, I believe it will cost taxpayer citizens of this
country well more than $1 billion in out-of-pocket costs. I believe
that it will consume hundreds of millions of hours of their time.

Second, we know that what we are measuring or at least what
we have historically measured is not whether the taxpayers pay
the proper amount of tax. What we are measuring is the revenue
agent’s views as to the law, the revenue agent’s views as to wheth-
er the taxpayer has complied with applicable recordkeeping re-
quirements, and whether the taxpayer has satisfied the revenue
agent with respect to factual issues in dispute. Finally, we know
that this will take 4 years or more to complete.

What we do not know are the benefits that have been claimed
for the proposed 1994 TCMP, nor do we know whether there are
better ways to accomplish the stated objectives. In very brief terms,
five benefits have been cited for TCMP. The first is the historically
intended use of TCMP, which was to permit the IRS to score and
better select returns for audit.

It is often claimed that the result of TCMP is a decline in no-
change audits of more than 40 percent to less than 15 percent, and
to an increase in yield from examinations that are conducted.
While TCMP has performed an important function in this regard,
I believe that the primary factors causing that decline have little
to do with either TCMP or the formula. I believe those declines are
largely attributable to the IRS information returns program, which
was nonexistent in the late sixties, to a dramatic decline in audit
coverage of more than a sixfold decline, and to a more effective
targeting of the special examination programs.

question is—and I believe this is the question that should
always be asked—is it worth $550 million in taxpayer dollars, is
it worth what I believe to be $1 billion-plus of citizens’ money, is
it worth hundreds of millions of dollars of citizens’ time to achieve
whatever improvements might be achieved in the current IRS pro-
cedure for scoring returns? My own judgment is that the answer
is no. I believe that improvements in scoring could be accom-
plished, but I believe they could be accomplished far less expen-
sively and far less intrusively.

A second argument is that TCMP helps to identify compliance
trends. I believe that any study that takes more than 4 years to
complete calls into question on its face that assertion. Beyond that,
I would suggest by way of example the most single important non-
compliance trend of the late seventies and early eighties was tax
shelters. I believe that TCMP played no role in identifying that
trend. I believe the TCMP, if anything, inhibited the agency’s abil-
ity to respond.


123

Mr. HaNcock. Thank you, Ms. Long.
Mr. Feinstein.

STATEMENT OF JONATHAN S. FEINSTEIN, PH.D., PROFESSOR
OF ECONOMICS, YALE SCHOOL OF MANAGEMENT, NEW
HAVEN, CONN.

Mr. FEINSTEIN. Thank you, very much. I would like to also loose-
ly follow my written comments, omitting some things that have al-
ready been discussed today and adding a few remarks that might
be useful.

lam a professor of economics at the Yale School of Management
and I have studied noncompliance and tax enforcement for the past
8 years, working with both TCMP data and ordinary IRS audit
data and I will say a little bit about both of those. I have written
a series of research papers during that time, served on committees
overseeing IRS research programs, and worked with several State
tax authorities.

I am going to talk a little bit about my own experience with
TCMP and then comment on the usefulness of TCMP. I have
worked extensively with both the 1982 and 1985 TCMPs. I have
found TCMP data to be very clean with few, if any, missing values
or obvious miscodings, and I say that by way of contrast with some
other government data sets I might have worked with.

I have used TCMP to study three issues. First, I have inves-
tigated the relationship between household characteristics such as
marital status and self-employment, and the underpayment of
taxes. Second, I have calculated detection rates for individual IRS
tax examiners, demonstrating how TCMP can be used to help the
IRS evaluate the performance of its examiners. Third, I have esti-
mated the tax gap. If you extrapoiate forward, my estimates would
suggest that the tax gap presently is at least $120 billion. I would
consider that to be a conservative estimate. I would not be sur-
prised if it was quite a bit more than that.

The magnitude of the tax gap, I think, illustrates the importance
of IRS audit programs. I wanted to make one further comment
about that. If you look at other countries, the proportion of taxes
unpaid, that is the tax gap, compared to government revenues is
substantially higher. One important difference between those coun-
tries and the United States is that the IRS has a TCMP, I believe.

Now, the primary reason for conducting a TCMP is to help the
IRS develop audit selection guidelines. In the remainder of my tes-
timony I would just like to address whether TCMP is essential for
these audit programs or whether it could be replaced by cheaper
alternatives. I would like to say a bit about if it is essential, how
large should it be?

T just wanted to also begin by noting that IRS audit selection is
of a very high quality. IRS audit productivity, as measured by the
average audit assessment, has increased fourfold during the past
30 years controlling both for inflation and for the increase in tax
burden that has occurred during this time period. That is a very
high level of productivity increase.

if the IRS simply selected household returns for audit at random,
it would collect far less than $1,000 on each audit. Because it has
sophisticated methods to select households for audit, it currently


APPENDIX II APPENDIX II

Individuals
et
Population Sample size
of market Percent
segment Form | All that are
Market segment (000) 1040s_| returns | 10408
Nonbusiness-~no 66,069] 5,042] 5,042 100.0
schedules
Nonbusiness--no 24,647| 15,175] 15,175 100.0
Schedules C, E, or F
Nonbusiness with 10,250] 7,958} 7,958 100.0
Schedule E
Very small business 9,785 5,105 5,105 100.0
Farm business aso| 6,852] 8,602 79.7
Building trade 942 3,135 5,851 53.6
contractors
All other 226] 2,759] 6,049 45.6
construction
Manufacturing 2o1{ 1,502] 6,313 23.8
Mining and minerals 2e| 1,502] 3,457 43.4
Agricultural servic 233| 1,506] 3,067 49.1
Wholesale trade 2ai{ 2,167| 7,792 27.8
Direct sales to 187 1,506 1,595 94.4
individual
Auto and boat dealers 149| 1,504] 3,965 37.9
and service station:
Food and beverage 342] 2,841] 4,931 57.6
Apparel, furniture, 130] 1,506 3,540 42.5
and general
merchandise
Retail--all other 295| 1,526] 4,268 35.8
Real estate 312] 1,506] 5,759 26.2

Source: Final 199t TCM Sample Design-




149

In the face of this reality, the only reasonable thing to do is
discontinue TCMP audits and redirect the expense to examiner
training.

2. The IRS is Unable to Assimilate or Use the Data it has.

Even assuming the IRS is able to obtain accurate data through the
TCMP process, the facts indicate the agency is incapable of putting
the information to good use.

Over the years, the GAO has uncovered deplorable deficiencies in
the IRS' own internal system of recordkeeping and accounting. These
are just a few of the facts:

a. Weaknesses, oversights and failures in the administration of the
IRS information systems substantially increase the risk of fraud
and seriously undercut the reliability of data used in management
decisions. GAO/AIMD-93-34, September 22, 1993.

b, The IRS lacks any degree of accountability over its automated
data processing equipment. Despite having spending billions on ADP
equipment in the process of modernizing IRS computers, the agency
cannot account for what it has, how the equipment is used, its
value, etc. GAO/AIMD-93-24, August 5, 1993.

¢. The first audit of the IRS' financial statements showed, among
other things, the incredible fact that the agency was unable to
account for 64 percent of its entire 1992 Congressional
appropriation. The report also revealed numerous examples of fraud,
malfeasance and nonfeasance on the apart of IRS employees changed
with the duties of keeping the agencies books and completing its
financial reports. GAO/AIMD-93-2, June 30, 1993. See also GAO/T-
AIMD-93-4, August 3, 1993 (testimony of Charles Bowsher,
Comptroller General of the United States).

d. IRS was unable to correctly account for its receivables ledger.
Serious problems were found in that IRS could not justify the
entries claimed to be accounts receivable. Many were based upon
erroneous assessments, uncredited payments, etc. GAO/AFMD-93-42,
May 6, 1993.

e. Audit of IRS’ 1993 financial statements revealed ongoing,
systematic problems with the agency's accounting practices. Audit
findings show the IRS is simply unable to keep accurate books and
records of account. These findings are similar to those set forth
in paragraph (c) above. GAO/AIMD-94-120, June 15, 1994.

But there is even more compelling evidence of IRS ineptitude,
specifically in the area of its enforcement programs. This is
directly relevant to the question of TOMP audits.

The GAO has specifically found that the IRS' estimates of revenue
generated from its enforcement programs are simply unreliable. The
agency does not support its estimates with any facts that allow
GAO's auditors to verify them. In the words of the GAO, "* * *In
fact, however, IRS does not know how much revenue its enforcement
programs actually generate." Tax Policy and Administration, IRS
Needs More Reliable Information on Enforcement Revenues, GAO/GGD-
90-95, June, 1990 (emphasis added) .

In sum, the IRS makes glowing statements concerning the value of
its enforcement programs, including TCMP, but in realty, it has no
clue whether the programs ever produce the intended results. When
we couple the IRS’ fundamental lack of recordkeeping with audits we
know are incorrect, we must conclude that TCMP audits are simply


COMMITTEE ON WAYS AND MEANS.
BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois SAM M. GIBBONS, Florida

BILL THOMAS, California CHARLES B. RANGEL, New York
E. CLAY SHAW, JR., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ANDY JACOBS, JR,, Indiana

JIM BUNNING, Kentucky HAROLD E. FORD, Tennessee
AMO- HOUGHTON, New York ROBERT T. MATSUI, California
WALLY HERGER, California BARBARA B. KENNELLY, Connecticut
JIM MCCRERY, Louisiana WILLIAM J. COYNE, Pennsylvania
MEL HANCOCK, Missouri SANDER M. LEVIN, Michigan
DAVE CAMP, Michigan BENJAMIN L. CARDIN, Maryland
JIM RAMSTAD, Minnesota JIM McDERMOTT, Washington
DICK ZIMMER, New Jersey GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia

SAM JOHNSON, Texas L.F. PAYNE, Virginia

JENNIFER DUNN, Washington RICHARD E. NEAL, Massachusetts

MAC COLLINS, Georgia
ROB PORTMAN, Ohio
GREG LAUGHLIN, Texas
PHILIP S. ENGLISH, Pennsylvania
JOHN ENSIGN, Nevada
JON CHRISTENSEN, Nebraska
PHILLIP D, MOSELEY, Chief of Staff
JANICE MAYS, Minority Chief Counsel

SUBCOMMITTEE ON OVERSIGHT
NANCY L. JOHNSON, Connecticut, Chairman

WALLY HERGER, California ROBERT T. MATSUI, California
MEL HANCOCK, Missouri SANDER M. LEVIN, Michigan
SAM JOHNSON, Texas BENJAMIN L. CARDIN, Maryland
ROB PORTMAN, Ohio JIM McDERMOTT, Washington

JIM RAMSTAD, Minnesota
DICK ZIMMER, New Jersey
GREG LAUGHLIN, Texas

ap


119

mandate, and the "Tax Model" files and related SOI reports which
continue to this day are relied upon by IRS, the Treasury
Department, Congress, scholars, and the public at large.

The SOI data, however, reflect tne information that is
reported on tax returns. Not all taxpayers file required returns,
and the information reported on returns that are filed is often
incorrect. This is where TCMP comes in. It examines the tax
compliance behavior of 120 million business and nonbusiness
taxpayers by looking at the behavior of a relatively small
scientifically valid ‘random sample." This program and its
predecessors! dates back to at least the 1940s -- almost fifty
years.

There are countless examples of how TCMP has provided
indispensable information that could not be obtained in any other
way. Specific legislative and administrative improvements taken
as a result of TCMP findings are well-known and have saved
taxpayers many, many times the cost of the program.?

The plain fact is that there are no known substitutes for
this approach that will produce comparable information. In the
late 70s, for example, the Justice Department commissioned a
comprehensive study on measuring white collar crime. This study,
which I worked on, singled out IRS's TCMP program as the model
which offered the only generic approach for measuring most
regulatory and white collar offenses.? I am unaware of any magic
breakthrough that changes this assessment today which would offer
a substitute for the TCMP approach.

GETTING THE MOST OUT OF TCMP

While I view TCMP as an essential tool for good government,
one question must be examined: Have we gotten the most mileage
from it? In my opinion, the answer is no. It would be a
surprising government program, of course, where there was no room
for improvement. One very simple but obvious point is that for
information to have value it has to be distributed and used.
Because IRS for far too long sought to restrict access to these
data, society has not reaped the benefits from TCMP that are
possible, Even within the agency itself, the insights provided by
TCMP data have not been sufficiently exploited.

I believe TCMP data are as essential to the nation as
Commerce and Labor Department information on the economy and even
Census data on the population. This is because TCMP provides
powerful facts and insights that could lead to improvements in the
tax law and its administration. The potential impact here is hard

1 The Bureau of Internal Revenue (as the IRS was then called)
launched the Audit Control Program right after World War II using
audits of random samples of taxpayers to measure taxpayer
compliance. TCMP as we know it was formally launched in 1962.

2 For examples of TCMP uses see Internal Revenue Service,
Documentation, Document 9293 (Volume I (1993) and Volume IT
(1994); Internal Revenue Service, i
Program Handbook, Document 6457 (Revised Edition, 1989); General
Accounting Office, i 2

i , GAO/GGD-95-39 (December
1994); George Guttman, "Taxpayer Compliance Measurement Program:
Is It Necessary?" Tax Notes, June 5, 1995, pp. 1282-1288.

3 susan B. Long, i
. Washington, D.C.: U.S.
Government Printing Office (1980).


68

TIN's for tots. One of the success sto-
ries frequently attributed to TCMP involves the TIN’s for
tots legislation enacted during the 1980's. Myth has it
that TCMP caused IRS to figure out that taxpayers were
overstating the number of dependents and that the problem
might be solved by requiring taxpayers to obtain and list
Social Security numbers for their children. Some have
suggested that the revenue gains from just this one
change more than cover the costs of TCMP.

In reality, the process was, as it should be
far different. The starting point was the recognition
that voluntary compliance improves when the taxpayer has
the information necessary to comply with the law and
knows that the IRS has independent means to verify such
compliance. The TIN‘’s for tots proposal was the logical
outgrowth of this analytical framework. Common sense
suggested that, with no means for IRS to easily verify
claims, taxpayers could overstate their dependents with
no real fear of challenge. Requiring taxpayers to obtain
and list Social Security numbers seemed like an obvious
relatively unintrusive way to improve compliance. TCMP
data verified the hypothesis and provided a revenue
estimate for purposes of scoring the legislation. All of
the thought that prompted the TIN’s for tots legislation
could and should have been accomplished without TCMP

The hypothesis could have been tested, and revenues
estimated, through a targeted research effort that would
have been inexpensive, unintrusive, and completed in
several months.

EITC ems. The 1988 TCMP data has been
cited frequently in Congress and by the media for the
proposition that the EITC is rife with fraud and noncom-
pliance. This assertion is misleading for several rea-
sons.’ First, as noted above, the 1988 TCMP measured a
revenue agent’s judgement as to whether a taxpayer had
complied with the law and applicable record-keeping
requirements. We believe that many of the adjustments
proposed during the 1988 TCMP audits would not have been
sustained on administrative appeal or in litigation. The
fact that a low income family cannot produce marriage and
birth certificates and detailed information regarding
family budgets -- to satisfy the demands of an IRS agent
-- proves very little. To be perfectly frank, while EITC
changes may be warranted, we would not base any policy
decisions on the noncompliance estimates provided by the
1988 TCMP.

Second, the 1994 version of the EITC is far
different from the 1988 version of the EITC. Moreover
the IRS is now taking numerous steps to improve compli-
ance with the law as amended. The simplifying changes
since 1988, together with ongoing IRS efforts in this

. As a preliminary matter, while the 1988 TCMP data
suggested high levels of noncompliance, it did not
suggest that the noncompliance was intentional or
fraudulent.


152

to support those living expenses. This kind of "examination" is one
reason the IRS' audit results are so often wrong.

TCMP audits are deeply invasive. They involve unearthing the most
private aspects of a person's life. These are the kind of things
the FBI or local police could never get access to without a search
warrant. Yet the IRS merely demands the material and expects
compliance under penalty of law. Citizens who have done nothing
wrong are made to feel like criminals. Since the burden of proof in
all matters is upon the citizen, not the IRS, they find themselves
having to prove their innocence as to every line of the tax return.

I believe and assert there is much more to the TCMP audit than IRS
is willing to tell. We know it cannot be simply a matter of data.
The agency cannot correctly use the data it has. I believe the real
issue is one of "presence.”

For the years, the IRS has expressed the desire to "create and
maintain a sense of presence” in the lives of all Americans. This
idea was clearly expressed in a 1984 document entitled, Strategic
Plan, IRS Document No. 6941. Creating "presence" means building the
notion in the minds and hearts of all Americans, that the IRS is
"watching you." The IRS insisted in its 1984 plan that creating
presence was vital to "encouraging voluntary compliance."

More than anything else, TCMP is about creating presence. In this
context, the results of TCMP audits are irrelevant. The data
gathered is inconsequential compared to the enforcement gains
achieved by persuading every American that the IRS is "watching
you." This amounts to psychological warfare waged by the government
of the United States, through the IRS, on its own citizens.

To the extent that TCMP is an integral part of the effort to
"create and maintain presence," the undertaking is outrageous,
especially in light of all the forgoing.

Given the IRS' lack of ability to do the same with regard to its
own financial matters, it is unreasonable to lay those burdens at
the feet of the American people.

4. Why Voluntary Compliance is Declining.

IRS maintains the reason TCMP is so necessary, is that voluntary
compliance is in decline. IRS insists it needs TCMP data to
understand the treads, to be able to deal with the enforcement
problems of the day.

I can tell this Subcommittee in one sentence why voluntary
compliance is in decline. I can explain very simply why the tax gap
continues to grow, despite every enforcement program ever funded, I
can explain why the number of tax return nonfilers is growing along
with the underground economy. I know because I deal with these
people every day. I listen to their stories. I help them through
their problems.

The reason for the drop in voluntary compliance is very simple.
More and more Americans are simply unable to pay the taxes they
owe. Federal, state and local tax rates now consume more than 40
percent of a person's gross income. More citizens every day are
forced to make a choice between paying. their taxes and feeding
their families. One in such a position will opt to feed the family
every time -- without question and without hesitation.

To solve the problem of voluntary compliance, we must conquer the
federal government's insatiable demand for more revenue. If revenue
demands do not stabilize, then shrink in relationship to individual


79

Chairman JOHNSON. Thank you.

Dr. Sparrow, those 1 million audits that the IRS does, what in-
formation did they turn up about deductions?

Mr. SPARROW. The focused audits do continually provide feedback
to the IRS about different forms of noncompliance, as does any fo-
cused inspection by a regulatory agency. Whenever you go to delve
into one matter believing that you knew what the problem was,
you come away a little better educated, and sometimes you will see
things that you were not looking for.

But the danger is that, in massive systems such as the IRS, you
can completely miss some patterns of noncompliance. There is a
feature of tax noncompliance and it is a feature shared with all
kinds of other compliance areas that the problems do not reveal
themselves automatically, unless somebody goes——

Chairman JOHNSON. Y appreciate that, but I should think the
problems like alimony reporting, like the deductions for children, it
seems that those might have raised their heads in the million an-
nual audits.

Mr. Sparrow. Yes.

Chairman JOHNSON. Why do they require such an extraordinary
effort? First of all, do you know whether they did or did not?

Mr. Sparrow. They do undoubtedly.

Chairman JOHNSON. They come to the agency’s attention through
the normal audit course?

Mr. Sparrow. I think it is most unlikely that TCMP would show
a form of noncompliance which was totally new and that nobody
had ever seen. But I think perhaps its value is in helping you to
understand the magnitude and relative importance of different
problems.

I can provide an example of an issue that the IRS was well
aware of, but did not really understand the magnitude of. I did
some work for them on the electronic filing program and the fre-
quency of fraud in that program. They knew that that was a prob-
lem and they were detecting a fair number of fraudulent returns
coming through that system. But it was not until the 1994 filing
season when they actually did a scientifically constructed and sta-
tistically valid random sample from which they were able to ex-
trapolate to the whole population that they discovered the size of
the problem.

Chairman JOHNSON. So your study of EITC, the earned income
tax credit, would be an example of a targeted study that developed
from the normal compliance process, would it not?

Mr. SPARROW. It was different from the TCMP in that it was fo-
cused on one particular kind of return.

Chairman JOHNSON. Last, so I do not keep my colleagues waiting
too long, what is your response to the fact that the TCMP did not
indicate the widespread abuse occurring under the shelter law?

Mr. SPARROW. I am not familiar with that particular form of non-
compliance.

Chairman JOHNSON. Mr. Gibbs, would you like to comment on
that?

Mr. Gipps. I guess I would comment this way: I have said before
that there are certainly shortcomings and there are certainly defi-


15

Madam Chairman and Members of the Subcommittee:

We are pleased to be here to assist the Subcommittee in its
inquiry into the Internal Revenue Service’s (IRS) Taxpayer
Compliance Measurement Program (TCMP). CMP is a key component
of IRS’ overall compliance strategy, providing both baseline
compliance measurements and data to help IRS improve its
compliance programs. IRS collects TCMP data by performing audits
on a random sample of taxpayer returns in which every line of
every return is examined.

My statement today covers the importance of the TCMP, our
conclusions on criticiems of the TCMP, and features and status of
the planned TCMP of 1994 tax returns.

I would like to begin with a brief description of TCMP.
TCMP AND ITS USES

CMP began in 1962 when IRS recognized the increased importance
of measuring compliance with the tax laws. Since then, TCMP
audits have covered 11 different types of returns. TCMP audits
of individual returns have been the most frequently employed,
generally being conducted every 3 years. CMP audits have also
been conducted on the returns of corporations, partnerships, and
S-corporations, but less frequently than on those submitted by
individuals. It has taken IRS more than 4 1/2 years to complete
a TCMP. This time frame covers the planning phase (which occurs
before tax returns are filed) to final data analysis, which
includes estimating compliance levels and developing formulas for
selecting returns to audit in succeeding years.

TCMP is a unique tool in IRS’ array of strategies to measure and
correct noncompliance. It is the only tool that allows IRS to
make statistically reliable estimates of compliance nationwide.
TCMP data are also important to non-IRS users in congressional
and executive branch agencies and academia for policy
formulation, research, and revenue estimation purposes.

IRS uses TCMP data to develop objective, mathematical formulas,
which it then uses to score returns for audit selection. In this
way, IRS can make more efficient use of its audit resources and
avoid burdening compliant taxpayers. For example, in 1968, the
year before IRS started using this scoring system, about 43
percent of IRS’ audits resulted in no change to an individual’s
tax liability. By using TCMP-based formulas, IRS has been able
to more accurately select tax returns requiring changes, thus
reducing the no-change rate to less than 15 percent in 1994.

Also, given TCMP’s statistical validity and comprehensiveness, it
is useful for identifying compliance trends for specific issues
and groups of taxpayers. For example, by analyzing 1979 and 1982


128

Mr. Hancock. Thank you, Dr. Feinstein.
Mr. Smith.

STATEMENT OF KENT W. SMITH, PH.D., SENIOR RESEARCH
FELLOW, AMERICAN BAR FOUNDATION, CHICAGO, ILL.; AND
FORMER MEMBER, COMMISSIONER’S ADVISORY GROUP,
INTERNAL REVENUE SERVICE

Mr. SMITH. Mr. Chairman, and members of the subcommittee,
first let me note that I am speaking as an individual social sci-
entist researcher and my comments do not necessarily reflect the
views of the American Bar Foundation.

In my research on tax compliance administration since 1983, I
have used the TCMP data in both tabular form and by special runs
that the IRS research staff did for me. My comments are also in-
formed by other research we have done on taxpayers’ views and on
research on State individual income tax audits that my colleagues
and I have done in cooperation with the Oregon Department of
Revenue, but at the State level this time.

Let me summarize most of my comments that are in the written
testimony and highlight a few of the points. First, as others have
argued, the TCMP detailed line item data for a statistically rep-
resentative sample of tax returns has permitted a wide range of
analyses by the Service, by many other administrative and legisla-
tive offices that have not een represented in the testimony today
and by academic social scientists. As others have said, many of
these analyses could not have been done with other types of data.

Two essential characteristics of the TCMP are that it, No. 1, in-
cludes a statistically sound sampling of returns that is at some
level of stratification independent of the expected levels of non-
compliance.

In the current form, there is an oversampling of the strata of tax-
payers where there is the highest amount of noncompliance so
there is a weighting toward an expectation of primarily picking up
noncompliance or a heavier amount of that. It is not just simply
a random sampling of the entire population of taxpayers.

No. 2, the other essential characteristic is that the audits are
broad ones, examining all relevant aspects of the taxpayer's finan-
cial and tax situations. Without those characteristics, the data from
the TCMP would be statistically biased and the conclusions could
very well be misleading.

Several issues are frequently raised about the design efficiency
and burden of the TCMP. About timeliness. For several reasons I
believe it is probably unavoidable that it will take 2% to 3 years,
at a minimum, from the end of a tax year to a time when one can
have clean data and compliance estimates from an accurate high-
quality, TCMP data cycle. That is built into the nature of the tax
hling process and the timing of when taxpayers file and the audit-
ing process. One has to be concerned about the taxpayers and the
time and social and business obligations they have. You cannot
rush an audit because that increases the burden on the taxpayers.
If she had not had the time, if Ms. Smith had not had the time
to get her records together, it would have been much more burden-
some for her, for instance.


134

+ Patterns of noncompliance are continuing changing, and basing TCMP selection and
auditing on past auditing experience is likely to miss some of these changing patterns,
at least in a timely manner. As someone once observed, tax compliance is like a leaky
hose. As soon as one hole is patched, another one springs out, often in direct re-
sponse. Looking where the old leaks were is not the best way to find the new ones:
the entire hose must be inspected.”

‘+ There is also an important compliance reason for probability samples and general au-
dits. Because opportunities for noncompliance come and go, all taxpayers should have
the perception that there is some probability, however small, that their returns might
be audited, even if they think they have prepared them so that they will be beyond sus-
picion. That audit presence for everyone is a deterrent factor, but I and others feel
that itis also a important contributor to the normative support for trying to comply
with tax laws. “If the government doesn’t take my compliance seriously enough to be
concerned about it, why should I?” Even though the TCMP sample is a minuscule
percentage of returns, it helps to provide this deterrence and normative underpinning
for compliance.

Concerns about TCMP Audits: Some Observations

Several issues are frequently raised about the design, efficiency, and burden of the TCMP.
My comments about these issues are based on my own experience with TCMP data, discus-
sions with IRS staff, and my analyses of Oregon state individual income tax audits.

Timeliness. For several reasons it is probably unavoidable that it will take two and a half to
three years from the end of the tax year to obtain clean data and compliance estimates from an
accurate, high quality TCMP cycle. Taxpayers who file late have different financial situations
and taxpaying orientations than those who file early. The TCMP sampling must include both,
so it cannot be completed until at least 6 months after the filing date. Once an audit begins, it
often takes considerable time to obtain documents from third parties, and good auditors need
to respect the many other business and personal obligations of the taxpayers being audited,
Even with perfectly clean data, it still takes time to create the data base, double check for
inconsistencies, and conduct the initial analyses. Thus, a 3-year lag may be an inevitable con-
sequence of the nature of tax filing and auditing.

The data entry and checking procedures planned for the 1994 TCMP should decrease the
time needed for cleaning and organizing the data, but I suspect more could be done to speed
up this part of the process, especially by improving the accuracy of the initial data input by the
auditors—"getting it right the first time” in the parlance of Total Quality Management, What
concerns me more, however, is the amount of time between TCMP cycles. If there are three
years between samples of & particular type of return, then tax policy and administrative analy-
ses and audit selection models have to rely on data that are up to 6 years old, given the un-
avoidable 3-year lag.

Sample Size. Others today can address the issue of sample size more authoritatively t
can, but I doubt that the sample can be decreased very much if we are still to have statistically
sound data, The stratified sampling design, especially as improved for the 1994 TCME, is
already allowing considerably smaller samples than would an unstratified random sample of
audits. As T noted before, compliance on one line item is generally not highly correlated with
compliance on other li
each line item requires quite large overall samples. Also, some types of important noncompli-
ance are rare and unpredictable from available data: large samples are needed to increase the
probability of including these often large but rare cases of noncompliance. Moreover, the
factors related to various types of noncompliance vary considerable across categories of tax-

7. Lest the analogy be misunderstood, let me note that the primary reason why the com-
pliance hose is leaky is not that the tax system is old or brittle. More fundamentally, the leaks
‘occur because the financial and social situations of tax entities are complex and forever
changing, resulting in both intentional and unintentional noncompliance; because some entities
will try to take a “free ride” when the opportunity exists; and because for some the utility and
satisfaction of keeping a dollar away from the government is worth more than a dollar.



74

In part the increased cost of the 1994 TCMP results from
an attempt by the IRS to develop data to provide better answers to
important questions previously raised by this Subcommittee and
others in Congress about the extent of tax compliance under our
Present system. or example, this Subcommittee over the last

several years has held several hearings to discuss the extent of

compliance, or noncompliance, by subsidiaries of foreign
corporations doing business in the United States. Part of the 1994
TCMP is designed to develop meaningful data to provide better
answers to the important questions previously raised by the
Subcommittee in that regard.

Yes, TCMP audits involve some additional taxpayer burden.
But as a taxpayer who has undergone a TCMP audit previously, I
believe the taxpayer burden arguments are overdone, particularly
for compliant, well organized taxpayers. IRS takes steps at the
beginning of a TCMP audit to minimize the cost and pain of the
actual TCMP audit if taxpayers will prepare for the audit by
initially organizing their tax information to permit them to more
readily answer the auditor’s questions. If taxpayers do not do s0,
or do not have the necessary data to support their income and
deductions, then the process can be long and painful, as is usually
the case in the normal audit for the same reasons.

Yes, TCMP results are imperfect in determining taxpayer

compliance levels and the amount of tax being lost to
noncompliance. TCMP certainly does not answer all of the important
questions about how to improve taxpayer compliance and minimize
noncompliance, and I continue to support the IRS requests for
additional appropriated funds (or even the reallocation of existing
compliance funds) to support more compliance research. Without a
doubt, there is room for continued improvement in all of these
areas.

Unless and until a better overall, comprehensive, and
credible method to determine and measure tax compliance and the tax
gap is developed and tested, I believe it would be a mistake to
abandon the TCMP. We can, and should, use the current criticisms
to improve the TCMP, but we ought not to abandon it. Tt may be
fashionable at present to simply decide to “start over" when
something does not meet our expectations. In the case of the TCMP,
I believe to do so would be unwise.

Thank you for inviting me to testify. I will be happy to

answer any questions.


32

APPENDIX IT APPENDIX II
Table 11.4: Market Segments and Sample Sizes for IRS’ 199¢ TCMP--
Partnerships
Market Sample size
segment Percent
population | Form | All that are
Market _segment (000) _ 10658_| returns | 10658
Finance and insurance 134 690| 4,040 17.1
Air, bus, and taxi 3 316] 2,805 11.3
Other transportation
and utilities 23 624] 3,703 16.9
Amusement, 23 607} 3,671 16.5
recreation, and
motion pictures
Medical and health 29 689| 5,034 13.7
Business and personal 16 696| 6,144 11.3
services
Hotel, lodging, 58 691 5,473 12.6
automotive
Unable to classify 7 696 15,317 4.5
Miscellaneous Not o| 2,382 0.0
business and personal | available
services
Miscellaneous 72 659| 5,496 12.0
services
Total* 1,501] 12,488 | 152,534 8.2

“Totals may not add due to rounding.

Source: Final 1994 TCMP Sample Design.

(268676)


103

at all. There are data bases out there that the Service could access,
commercial data bases which would give them participants in given
industries.

For example, what they are doing in the market segments ap-
proach is a much more realistic and much more profitable approach
in terms of the use of their resources than to go out and spend $2.1
billion on this TCMP that is going to drag 40 percent of taxpayers
in and result in refunds, or no changes.

In addition, the cost to the taxpayers and small businesspeople
to comply with this TCMP is just enormous. The testimony we had
this morning by Mr. Brand of about 1 hour or 1¥2 hours per audit,
that may be what the national office thinks happens, but in reality
what happens in the field is different. The taxpayer that Mr.
Zimmer described that would be assigned to a fairly low-graded
auditor and the fact that the TCMP is given such an emphasis
within the Service—plus the fact that they have all gone through
this economic reality training this year, that taxpayer who walked
in and refused to turn over the records of a noninterest bearing ac-
count would be treated like Al Capone.

There is no question that the auditor would get a summons is-
sued for the checking account data and there is no way, under any
circumstances, that it would be a 1¥2-hour audit. I can assure you
of that.

It would turn into a major controversy with that taxpayer. There
is no way, in a TCMP especially that you are going to tell some
tax auditor you are not going to give him the information on the
bank account. The first request the taxpayer got notifying him
would have told him to bring in all of his bank statements for the

ear.

That is just the reality. So I do not know what the national office
thinks is happening out there, but what is actually happening on
the street is that they would treat that a lot differently. It would
be a much more thorough audit if the taxpayer did not provide all
of the data that was requested in the information document re-
quest.

Mr. HaNcock. Well, do you think that even on the TCMP you
did not get the idea of assumption there, the assumption of guilt,
something being wrong. But in your jodgment, especially with the
way some of these audits have been handled that you are familiar
with, that there is an assumption on the part of the auditor that,
in fact, there has been something wrong, rather than just saying,
look we are running a compliance check here.

Mr. LANE. TCMP gets two reactions in the field. The experienced
revenue agents Benerally consider it a nuisance because it is a ran-
dom sample and they know, therefore, that some of these people
are going to be refunds or no changes. Their attitude is it is a
waste of time. We ought to audit people that we know we can iden-
tify through some other vehicle that are a lot more likely to result
in audit changes, higher DIF scores for example.

Newer agents, and there are a lot of new agents out there, have
not been through a TCMP before and they see the emphasis the
Service gives it. They see things like congressional hearings and
newspaper articles on it and they take away a frame of reference
that this is a really hot issue. They get special reports they have


39

Ms. Stathis, in your testimony, you state that the additional rev-
enues for the TCMP analysis far exceeded the costs. You gave the
example of requiring dependent Social Security numbers to be in-
cluded and that caused, in 1 year’s time, 7 million dependents to
be dropped from the claim.

How much revenue did that produce by the dropping of these 7
million dependents, and can you tell us how that related to the cost
of the TCMP?

Ms. STATHIS. In our 1993 report, we show that the individual
TCMP, the last one that was done, cost $88 million. The Joint
Committee on Taxation had estimated that the dependent SSN
change would bring in $300 million a year. I believe that estimate
was Before the actual number of 7 million dependents was realized,
however. I have seen different estimates on the 7 million, ranging
from $1 billion up to $3 billion a year. So I am not quite sure what.
the right number is but I think it is probably the billion dollar fig-
ure.

Mr. LAUGHLIN. A billion dollars in additional revenues resultin;
from this 7 million dependents being dropped from the tax returns?

Ms. STATHIS. That is right.

Mr. LAUGHLIN. Now, what other examples—first before I go
there, did those 7 million dependents that were dropped show up
as taxpayers somewhere else or did the TCMP indicate what hap-
pened to the 7 million that got dropped?

Ms. STATHIS. No, the TCMP was what led to requiring taxpayers
to report dependent SSNs. The numbers that were dropped, the 7
million, come from a comparison of the number of dependents who
were reported on 1986 tax returns versus the numbers who were
reported on 1987 tax returns.

ir. LAUGHLIN. Can you give us any other examples of changes
that resulted in additional revenues? Again, give us the relation-
ship the change caused by way of increased revenues and cost to
the TCMP.

Ms. STATHIS. Well, for example, real estate gains are now re-
quired to be reported——

Mr. LAUGHLIN. Real estate what?

Ms. STATHIS . Real estate transactions. IRS now gets some form
1099 reporting on real estate transactions because, through TCMP,
IRS determined that there was a tax gap in that area approachin
$8 billion. Stock transactions are now reported because that hai
been found to be about a $2 billion tax gap issue.

Generally, when additional reporting on a tax return or through
a form 1099 information return is required, IRS expects it to in-
crease voluntary compliance and, thus, more of that type of income
will be reported,

Going back to Chairman Johnson’s question earlier about unre-
ported income, one of the proposals that the Service offered uy
year or so ago was something called SINC. I have forgotten what
the acronym stood for but SINC, too, was a proposal to have more
information reporting on this type of cash income.

Information reporting generally has proven to increase compli-
ance levels and bring in greater revenues.

Mr, Bran. Mr. Laughlin, if I might, I might be able to give you
a couple of more examples if you are interested.


64

Moreover, many people will no doubt have ex-
hausted their taste for dealing with the IRS after expe-
viencing a TCMP audit. As a result, they may be less in-
clined than taxpayers undergoing regular audits to pursue
those issues through appeals, particularly if the dollar
amounts are not substantial. Indeed, some taxpayers may
make this kind of cost-benefit calculation during the
TOMP audit itself (choosing, for example, not to spend
$2,000 and a lot of time documenting and challenging a
potential adjustment of $1,500).

B. What Will TCMP Teach Us; What Will We
Do With What We Learn? ‘CMP is supposed to accomplish
four objectives: (1) improving the selection of returns
for examination; (2) measuring the overall tax gap and
its primary components; (3) permitting the IRS, and
perhaps Congress to design and implement improved compli-
ance strategies; and (4) providing useful statistical
information to other users (e.g., the Commerce Department
and private researchers) .

1. Selecting returns for audit.
Originally, TCMP’s sole purpose was to help the IRS
select returns for audit. The application of various
statistical techniques to TCMP data permitted the IRS to
"score" returns based on their anticipated audit yield.
In this respect, TCMP has made an important contribution
to tax administration. Indeed, the most frequently cited
data in defense of TCMP is that "no change" audits have
declined from more than 43% in 1968 to less than 15% for
1991, and that examination yields per return audited
during that period have increased.

Having said as much, however, it grossly over-
states the case to ascribe such results entirely to TCMP.
The decline in no change audits and increased yields have
resulted largely from the following (particularly since
the late 1970's): (1) the development and implementation
of a comprehensive information returns reporting and
matching program; (2) the dramatic decline in audit
coverage (to about one-sixth its level in the 1960's);
and (3) the improved focus of special program audits.

In this context, two points are worth emphasiz-
ing. First, we do not quarrel with the notion that the
IRS should minimize no change audits and maximize yields.
However, we are not convinced that this objective justi
fies the 1994 TCMP.

. It is far from clear that the proposed TCMP
would improve materially the "scoring" tech-
niques that the IRS currently has in place and
regularly modifies in light of other informa-
tion it receives (including information from
other audit and enforcement activities).

* The "general audit" program is currently at a
minimal level of less than one percent of re-
turns filed; it has been at that level for some
time; it seems very unlikely to expand in the
years ahead. With coverage at such low levels,
IRS has many more potential high yield returns
than it can audit. Any improvements due to the
1994 TCMP would be likely to have little prac-
tical value.


148

incorrect conclusions. This leads to the assessment of taxes,
penalties, interest which are simply not owed.

Recently, the GAO released the result of a study of the IRS'
Coordinated Examination Program (CEP). CEP is designed to audit the
largest, most complex corporations. Despite having spent 1,700
staff years to examine 1,700 such corporations, GAO was able to
confirm that only 22 percent of the amount of tax proposed through
audit was ever collected. See: Tax Policy and Administration,
Compliance Measures and Audits of Large Corporations Need
Improvement, GAO/GGD-94-70, September 1, 1994.

GAO generally cited two reasons for the tremendous difference in
the amounts of tax recommended by examination, versus that assessed
and collected. First is the complexity of the tax laws. This factor
gave rise to “opportunities for different interpretations" of
complex tax law issues. Secondly, IRS encouraged CEP teams to
"recommend more taxes in the shortest time possible." This not only
makes it difficult to do a complete audit, it makes it impossible
to do a correct audit.

While the above mentioned report dealt with complex corporate tax
audits, the results are no different in the examination of
individual taxpayers, or small business taxpayers. IRS examiners
are under the same pressure to close cases, and deal with the same
complex and ever changing tax law.

I recently completed my own detailed analysis of the accuracy of
IRS' audit results. My study was published by the Cato Institute,
on April 15, 1995. Drawing exclusively from IRS' annual reports of
the Commissioner, I present data which shows that IRS" audit
results are consistently wrong about 50 percent of the time. See:
Cato Institute Policy Analysis No. 222, Why You Can't Trust the
TRS, April 15, 1995. These findings are more generous than the 22
percent found by the GAO in above-cited report. However, they are
deeply troublesome from the standpoint of individual citizens.

Individual citizens certainly cannot afford the kind of legal and
accounting talent available to America's largest corporations. As a
result, citizens are far more likely to fall victim to erroneous
statements or out-right bluffs. They are far less likely to
exercise their right of appeal, which almost always leads to a more
accurate result than is reached by tax examiners,

The reason for this is Appeals officers are under strict guidelines
to settle cases solely on the basis of the law and facts.
Incredibly, tax auditors are under no such admonition. On the
contrary, they are under pressure to recommend taxes and close
cases, regardless of the law and the facts. See Revenue Regulation
601.106(f) (1) regarding appeals settlement rules; compare with
Revenue Regulation 601.104(a) (1) - (a) (4), regarding examination of
returns.

This reality leads to audit assessments which are plain wrong about
half the time. The results of TCMP audits are no more accurate than
any other type of IRS examination. In fact, given that every line
the return is relentlessly examined, I believe TCMP audits are more
susceptible to error.

Given the IRS' error rate in the conduct of audits, it is
unreasonable to continue to subject the American people to the
hassle, significant expense, time and anxiety of TCMP audits. The
IRS is aware of the problems it faces with regard to examiner
training. The agency recognizes that constant changes to an already
confusing law makes it virtually impossible for examiners with the
best of intentions to apply its countless facets correctly.


35

then is revitalized and brought forward with a series of economic
indicators that we get from different places. From these sources, we
are able to do an estimate. It is an estimate of the tax gap on those
actors.

Chairman JOHNSON. How much unreported income have you ac-
tually found in your last series of this sort?

Mr. BRAND. Using the last TCMP audit results for tax year 1992,
we have estimated a tax gap for individuals of basically $62.5 bil-
lion from unreported income.

Chairman JOHNSON. What proposals did you make to change the
law so that we would better get at that unreported income in the
future?

Mr. BRAND. There has been a series of proposals over the years.
I can give you three or four examples.

Chairman JOHNSON. OK.

Mr. BRAND. One of the things that we uncovered in a previous
TCMP was the fact that, by law, you are required, if you claim a
deduction for your State income tax refund in one year, you are re-
quired to report any refund in the following year as income.

A recommendation was made and the law was changed requiring
information reporting on that. The initial year that was worth $144
million in additional tax revenue. We also know, through TCMP
and other research methodologies, that TCMP statistically confirms
areas that we have concerns about but we are not able to statis-
tically confirm it.

In 1986, my recollection is that we asked for legislation, and
Treasury asked for legislation that would require the listing of So-
cial Security numbers to claim dependents. Almost 7 million de-
Pendents disappeared in the following tax year as a result of that
change.

There are a number of instances where, in fact, we felt there
may have been noncompliance and we were basically able to statis-
tically prove it through the sampling process. It has resulted in
revenues and tax law changes.

Chairman JOHNSON. So what I am gathering is you really are de-
riving information that has to do with compliance, and through
noncompliance avoidance of taxes. But you are not finding ways to
identify cash transactions that expand the income of many but do
not then become reportable and taxable?

Mr. BRAND. Our process of examination does require probes: for
unreported income and that is a major part of the methodology
that we use in examinations to verify income reported. The dif-
ference is that we do not attempt to use TCMP and we have not
been successful with other methodologies to develop tax gap esti-
mates of illegal sector income. We do not estimate the tax gap from
narcotics, prostitution, or activities that are illegal.

Chairman JOHNSON, I understand that. I am not looking so much
at illegal income. I understand the problems with that. I am look-
ing at, in a sense, the whole cash economy that moves without ac-
countability to the Federal Government for taxes due. The kinds of
things you are describing to me are enforcement and compliance
with existing tax law by taxpayers who are complying in general,
but not adequately.


67

+. + $150 billion .. - $300 billion? What will
Congress or the IRS do différently if the 1994 TCM
produces estimates that voluntary compliance levels have
gone up 2%. . . . have stayed the same... . have
declined 2%? will the Administration and Congress seek
different levels of funding for the IRS? Will the IRS
change its allocation of resources? The tax gap esti-
mates, whatever they may be, seem likely to have little
discernable impact on policies pursued by Congress and
the Administration. Moreover, we find it difficult to
imagine any different impact, whether the estimates are
derived from the 1994 TCMP or from other data sources

3. Improving voluntary compliance.
Another justification for TCMP is that it improves volun-
tary compliance by helping the IRS identify trends in
noncompliance and by leading to specific legislative
initiatives. We believe these particular claims are also
overstated.

(a) Trends in Noncompliance
Since it will take until the end of 1998 to complete the
1994 TCMP, claims regarding the ability of this exercise
te identify new trends in noncompliance are somewhat sus-
pect. The tax law, tax planning, and the context in
which those activities take place are all in flux. In an
environment characterized by frequent change, a study
that takes four years to complete can at best be of
limited use in identifying emerging trends

One practical illustration of this point is
provided by tax shelters and the 1976, 1979, and 1982
individual TCMP studies. During the late 1970’s and
early 1980's the retail marketing of tax shelters was
easily the most important compliance problem of that
period -- yet the TCMP studies did nothing to help iden-
tify the trend as it emerged. If anything, the IRS com.
mitment to its "scoring" and return selection techniques
distracted the IRS and delayed and distorted its re~
sponse. The tax shelter phenomenon could have been
identified and responded to far more rapidly through
observation and reflection in a work environment that
encouraged employees to "think" about the tax system, to
communicate with each other, and to focus on events in
the "outside" world

(b)_ Specific Legislative Ini-
ciatives. Despite recent IRS claims, TCMP is no key to
specific legislative initiatives. The critical elements
are an appropriate analytical framework, observation and
reflection, sound research and sampling, common sense,
and creative thinking. On occasion, TCMP data has been
used in recent years to test hypotheses and estimate
potential revenue gains from proposed compliance legisla-
tion. In this context, however, TCMP data is expensive
and often unsuited to the task. There are more effi-
cient and effective ways to identify areas of noncompli-
ance, and to assess the potential impact of various
compliance measures

Two examples illustrate this point: legislation
requiring taxpayers to obtain and list Social Security
numbers for their claimed dependents ("TIN’s for tots"),
and the current debate over compliance with the Earned
Income Tax Credit ("EITC")


104

to fill out and there are special detailed forms, so the impression
it creates for the newer agents is that this is a very highly rated
and important program. So they tend to approach it much less
flexibly than a normal audit.

They are given marching orders by their Superiors that they have
to audit every single line on the return and if there are any related
entities, they have to consider which related entities will also be
opened for exam. This is a much different environment than a nor-
mal audit where a fair amount is left to their discretion.

So it signals to the employees that this is a fairly important pro-
gram and 30 they are less flexible with the taxpayer as a result.

Mr. HANcock. In the preparation of the cost benefit analysis,
how would you recommend that they can reduce the cost to the tax-
payers for a TCMP audit?

ir. LANE. Well, one of our recommendations is that IRS take no-
tice that there are a lot of commercial data bases available. Just
to name a few, the Stanford Research Institute has a program
called the Values and Lifestyle Study. They have been gathering
data for 30 years now. If I am Procter & Gamble and I want to
know households that have $100,000 and more in income, and have
a Cadillac in the garage that is less than 2 years old, I can buy
a list of people that fit the criterion. I can custom design these lists
for marketing.

Our analysis is that before we’d go and spend. $2.1 billion of the
taxpayers’ money which is the true cost of this TCMP—the lost op-
portunity costs of those agents in the field and $559 million of the
program, itself—I would want to take a look at whether there is
alternative data that is already existing out there in Dun and
Bradstreet, and every place else in the world that you can buy.

I think there is no argument from the Service officials, if there
are any left in the room or the ones that were here this morning,
that the market segment approach is one of the best things they
have come up with in tax administration in the last 25 years.

They can prove it by two trends. No. 1, the average deficiency on
a market-segment audit is significantly higher than the average de-
ficiency in a general program audit. No. 2, statistics reflect increas-
ing compliance levels in given market segments once they have
been worked.

So why not focus your efforts, your money, and your resources on
market segments and identify more and more of those people who
are not complying and get those market segments into compliance.

I would try to buy these commercially available data bases. Now,
someone earlier, when we were talking on the break, indicated that
some of these companies would not sell the data to the IRS, and
that may be the case, I do not know. I am not a statistician; nor
do I go out and try to purchase these things. But I know they are
available.

Mr. HANCOCK. Thank you.

Mr. Keating, you expressed in your testimony that the timing of
this TCMP is poor as a result of possible major changes in the cur-
rent income tax law. Do you believe that there are aspects of the
current laws that may be important for the administration of fu-
ture laws under tax reform, for instance the reporting of income or
the timely payment of taxes?


126

TESTIMONY

To
Committee on Ways and Means
U.S. House of Representatives
Subcommittee on Oversight

By
Jonathan S, Feins
Professor of Economics

Yale School of Management

Tuesday, July 18, 1995

have studied tax noncompliance and tax enforcement for the past eight years. I will begin
my testimony by briefly describing my own experience with TCMP. In the remainder of my
testimony I will comment on the usefulness of TCMP for IRS audit programs, frst reviewing
‘some facts about IRS audit programs, and then discussing the way TCMP is currently used,
possible alternatives to TCMP, and the proposed expansion of TCMP.

Thave worked extensively with both the 1982 and 1985 TCMPs (Exhibits 1, 2, and 3). I
have found TCMP data to be very clean, with few if any missing values or obvious miscodings. 1
have used TCMP to study three issues. First, I have investigated the relationship between
household characteristics, such as marital status and self-employment, and the underpayment of
taxes. Second, I have calculated detection rates for individual IRS tax examiners, demonstrating
how TCMP can be used to help the IRS evaluate the performance of its examiners. Third, I have
constructed estimates of the tax gap for 1982 and 1985. My estimates suggest that the tax gap is
presently $120 billion or more. The magnitude of the tax gap illustrates the importance of
maintaining and improving IRS audit programs. A number of other economic researchers have
also made use of TCMP, including Daniel Nagin (Carnegie-Mellon University), James Poterba
(Massachusetts Institute of Technology), and Joel Slemrod (University of Michigan),

‘The primary reason for conducting a TCMP is to help the IRS develop audit selection
guidelines. Is TCMP essential for IRS audit programs, or could it be replaced by cheaper
alternatives? If TCMP is essential, how large should it be? In the remainder of my testimony I
will address these questions

Let me begin by noting that IRS audit selection is of high quality and has a significant impact,
on federal tax collections. IRS audit productivity, as measured by the average audit assessment,
has increased fourfold during the past 30 years, controlling both for inflation and the increase in
tax burden that has occurred over this time period. That is a level of productivity increase
matched by few other Government programs. If the IRS simply selected household returns for
audit randomly, its examiners would assess on average less than $1,000 on each audit. Instead,
the IRS relies on sophisticated methods to select households for audit, and its examiners currently
assess on average approximately $5,000 on each audit. The large difference between these
numbers shows how good the IRS has become at audit selection. IRS audit programs not only
generate direct audit assessments, but also generate additional indirect revenues through the
deterrent effect they exert on potential cheaters. Although indirect audit revenues are difficult 10
‘measure, most experts agree that they are substantially larger than direct assessments. Currently,
IRS examiners annually recommend approximately $7 billion in direct assessments based on audits
of households. Including indirect revenues, the total impact of the IRS's household audit program
on federal tax collections is likely to be substantially more than $15 billion per year.

‘Most observers are likely to agree that IRS audit programs play an important role in
safeguarding federal tax collections. There may be less consensus, however, about the
importance of TCMP for these programs. In fact, a considerable body of evidence indicates that
‘TCMP is critical for the design and implementation of IRS audit selection guidelines. I will
discuss two ways in which TCMP is useful for audit selection.

First, one of the most important uses of TCMP is in the development of DIF, a computer-
‘based rating system that assigns a number to each return, predicting the likely yield from auditing
the household that filed the return. During the past three years Brian Erard (Carleton University)
and I have investigated IRS audit programs in the Oregon district (Exhibit 4). Our analysis is
based on a large dataset we have assembled that includes most IRS audits of Oregon households
for tax year 1987. In our data we find that nearly one-half of all IRS audits are based on DIF.


45

The second issue I have generally is on the burden on the tax-
payer. Now, we can make that less, and I think that is in the inter-
est of all of us. Mr. Brand, as you indicated in your response to Mr.
Zimmer, it might take about 1 hour for a person in the $30,000 to
$50,000 range to respond to the audit. I think that is quite optimis-
tic, from my point of view.

T note that, based on some other testimony I have just read
through, that up to 60,000 of these returns may well be business
returns. I assume that is S corporations, partnerships, sole propri-
etors, and so on. I cannot imagine that it is going to take 1 hour.
I cannot imagine it is going to take 20 hours. I cannot imagine it
is going to take anything less than something like 20 to 100 hours
for those kinds of taxpayers to pull this information together and
to be responsive to all this information.

I have looked through your indirect methods worksheet that I
guess all the agents will have. I have looked through the compo-
nents of so-called economic reality, including club memberships, in-
cluding hobbies and toys and weddings, including level of sophis-
tication, cultural background, education and work experience, and
so on, alimony—there is a lot of information to be compiled and it.
is a very intrusive process. I think we ought to be realistic about
it and not talk about taking 1 hour of the taxpayer's time.

Mr. BRAND. Mr. Portman, I certainly would not want to have in-
dicated, though I believe that is the time that it would take for
most of the nonbusiness individuals involved in the TCMP. That
would be a mischaracterization on my part.

Mr. PorTMAN. What would you say the average is?

Mr. BRAND. Again, it depends on the type of tax return that is
involved—corporate, individual, business, schedule C. We can pro-
vide that information for the record and would be more than glad
to do that. I think that is an important issue. Again, I would not
want to leave this subcommittee with the fact that we do not un-
derstand that there is a degree of difficulty that this requires of
taxpayers, especially those involved in the no change.

The key here to remember, one thing I would ask you to remem-
ber, as you think about this process, is that it does have long-range
implications of fairness, because it does provide us with a basis of
selecting tax returns on some methodology that is developed and
understood, as opposed to us simply shopping for those who we
might think within our experience might be noncompliant. This
drives our methodology of scoring the selection of tax returns for
examination.

The second point that I would ask you to remember is that with ©
this system in the past, with the development of it, we have been
able to drive the no-change rate on millions and millions of other
taxpayers down to the point that we have been less intrusive. So
it is a tradeoff, no question about it.

Mr. PorTMAN. I would just make three comments. No. 1, if we
are talking about a 3-year or a 4-year life as we had in 1988, I
wonder whether it is going to be relevant. No. 2, I think there have
got to be ways, Mr. Brand, for us to make this more efficient than
what we are seeing here. It is sort of like a huge focus group. With
the current technology and the probability statistics of information
that we now have available to us, I find it hard to believe we need


87

of the purposes. Change it, adapt it, make it better, but I would
not abandon it.

Mr. HANCOCK. But is it not true that the TCMP only deals with
filed returns? It does not take care of the question of nonfilers, and
we do not even know what that is. We do not have the vaguest idea
of what that is.

Mr. Gress. My point 1 minute ago was that we have known
about the nonfiling problem for 20 years. What we have not been
able to get is a consensus about what type of system is right to
measure it, detect it, and then try to do something about it. There
have been folks outside the Internal Revenue Service, as well as in-
side the Internal Revenue Service, working on it.

My only point is do not abandon something that is working for
filed returns until you tell me what it is you are going to come up
with to deal with the unfiled returns or the unrepoi income.

Mr. Sparrow. I share your concern about the nonfilers and the
failure of TCMP to get at that issue. But nonfilers are at the end
of the day only one of scores of identified noncompliance issues,
and disbanding with TCMP loses your instrumentation on all of
those others. It would be a mistake to do that simply because it did
not address one. Rather, I would raise the question, if we have
TCMP and that does not address the nonfiler issue, what else do
we need to make sure that that particular critical noncompliance
area is not forgotten and is properly addressed?

Mr. Hancock. Does any witness have any other comment you
would like to make?

Mr. Sparrow. It has been very interesting for me to hear Mr.
Goldberg’s objections to this. He has stated repeatedly that there
are alternatives to the random methodology for scanning the hori-
zon for problems that you do not know about. It is true, there are.
You can use focus groups and surveys and you can guarantee peo-
ple anonymity. A lot of researchers at different times have tried to
use those tools to get valid and unbiased views of taxpayer behav-
ior. They are notoriously unreliable.

So I am relieved when my friend acknowledges that there is no
substitute for randomly selected returns, and that is a fundamental
piece of measurement machinery that all regulatory agencies have
to have available to them, if they are going to see clearly what is-
sues they are dealing with. That does leave open, though, the ques-
tion of how big, how often, and whether now is the right time. I
understand that those are important critical issues and they are
separate from the underlying question of should we allow random
audits.

On the question of how big and how often, I would just say in
terms of having a sensible data base from which to work, there is
now an accumulated deficit of 7 years, with no randomly generated
data, and it is urgent that that gap be filled.

Thank you.

Mr. HaNcock. We just got a call for two 15-minute votes, so we
are going to recess this panel and invite the next panel back
at 1 o'clock or thereabouts.

(Recess.]

Mr. Hancock. Welcome to the subcommittee. Thank you for ap-
pearing to testify to the subcommittee on a very important subject.


‘STATEMENT OF PHIL BRAND
CHIEF COMPLIANCE OFFICER
INTERNAL REVENUE SERVICE

JULY 18, 1995

Madame Chairman and Distinguished Members of the Subcommittee:

I appreciate the opportunity to appear before this Subcommittee today to
discuss IRS’ Taxpayer Compliance Measurement Program (TCMP) in general, as
well as our planned TCMP survey of 1994 tax returns,

Background

For over 30 years, the IRS has relied upon the information obtained from
TCMP to collect the proper amount of tax dollars due and owing. Statistically valid
data on compliance behavior enables the IRS to focus its compliance efforts on the
most noncompliant taxpayers. TCMP is the primary data source for determining,
measuring, and tracking taxpayer compliance levels. Thus, TCMP is one of IRS’
most important tools to improve compliance.

To determine compliance levels across a filing population, TCMP selects and
examines a randomly selected sample of tax retums. TCMP audits are designed to
review all aspects of the return and, thus, to determine whether the return reflects
the taxpayer's true tax situation. From these audits, detailed data on taxpayers’
teporting behaviors is captured and analyzed. From this data analysis, we can
determine the extent to which taxpayers correctly report their federal income tax
liability.

The first TCMP surveys were conducted in 1963 and 1964. One of these first
surveys involved the examination of 1963 individual (Form 1040) tax returns, Data
from this survey was used to develop a sophisticated, computerized system to
select individual and small business returns for examination. This system, still in
use today, is called Discriminant Function (DIF). DIF has significantly improved our
ability to identify and select the returns for audit with the highest potential for
change. DIF benefits taxpayers by significantly reducing the number of
examinations resulting in no change to the tax liability reported by the taxpayer. In
FY 1969 (prior to IRS’ use of DIF), 46 percent of the examinations resulted in no
change to the tax reported by the taxpayer. In FY 1973 (after implementing DIF),
examinations that resulted in no change to the tax return had dropped to 30 percent.
In FY 1994, only 19 percent of retumns selected for examination using DIF resulted
in no change to the tax return. This means that a significant number of taxpayers
who have correctly and accurately filed their returns are not burdened with an
examination.

‘Over the past 30 years, the IRS has conducted 25 TCMP surveys of various
types of returns. In all of these surveys, we have focused on specific segments of
the taxpaying population — individuals, corporations, partnerships, and S
corporations -- one segment at a time. Four separate surveys of these four types of
returns were conducted over a 7-8 year time period. The most recent surveys
conducted of each of the types of tax returns and the sample size of each survey
follows:

Individuals (Form 1040) 1988 returns 55,000 returns
Corporations (Form 1120) 1987 returns 19,000 returns
$ Corporations (Form 11208) 1984 returns 10,000 returns
Partnerships (Form 1085) 1981 retums 27,000 retums

Total Sample Size 111,000 retums

‘These surveys were designed to provide statistically valid data on compfiance
levels by return type (Form 1040, 1120, etc.) and by reported income/asset levels at
the national and regional level. Since the data from these surveys is 7-14 years old,
the IRS is selecting returns for examination and allocating resources based on data
that is not current. For this reason, the planned survey of 1994 tax retums is an
IRS priority.


TAXPAYER COMPLIANCE MEASUREMENT
PROGRAM

TUESDAY, JULY 18, 1995

HOUvSE OF REPRESENTATIVES,
COMMITTEE ON WAYS AND MEANS,
SUBCOMMITTEE ON OVERSIGHT,
Washington, D.C.
The subcommittee met, pursuant to notice, at 10 a.m., in room
B-318, Rayburn House Office Building, Hon. Nancy L. Johnson
(chairman of the subcommittee) presiding.
[The advisory announcing the hearing follows:}

io)


150

worthless in developing the data needed for effective tax law
administration.

In recent testimony before a House Appropriations Subcommittee,
Jennie S. Slathis of GAO described the problems found in verifying
the accuracy of IRS' enforcement initiatives. She states as
follows:

"* * *According to the IRS, the revenue data
to be used in measuring the success of the
compliance initiatives is to come from the
Enforcement Revenue Information System (ERIS)
=- a relatively new system designed to account
for actual collections resulting from IRS"
enforcement programs and to enable IRS to more
accurately measure and predict enforcement
costs and revenues. ERIS is not fully
operational, but IRS believes it will be by
the end of the year.

"We have some concerns about the reliability
of IRS' ERIS data. Those concerns derive from
an October 1993 IRS Internal Audit report
which says, in part, "information in ERIS
reports is still not accurate, reliable, or
consistent.'* * *" Tax Administration, Tax
Compliance Initiatives and Delinquent Taxes,
GAO/T-GGD-95-74, February 1, 1995.

The GAO reports cited above, taken as a whole, all point to one,
inescapable conclusion: The IRS is itself unable to keep books and
records or prepare financial statements. It is unable to do the
very things it asks every taxpayer to do.

Since the IRS is incapable of tracking something so basic as its
accounts receivable, how can it be expected to assimilate and use
the complex TCMP data? Since the IRS cannot provide accurate
information to Congress on the success of its various enforcement
programs, what good are TCMP data, even if they are valid? Since
the IRS cannot even keep track of its ADP equipment, how can it be
expected to track and use TCMP data? Since IRS cannot account for
64 percent its Congressional appropriation, what right does the
agency have to ask any citizen to justify the entries on every line
of every tax form filed with his return?

In the concluding remarks to its report on the examination of the
IRS' 1993 financial statements, the GAO makes this chilling, and
very relevant statement:

"Further, IRS' lack of fundamental
recordkeeping is inconsistent with
recordkeeping requirements placed on taxpayers
in support their returns and has far reaching
implications, not only to IRS' credibility as
the government's tax collector, but also on
the federal government as a whole to
responsibly use taxpayers funds. The IRS has
more direct contact with the public than most
government agencies and, as a result, the
public's perception of the federal government
as a whole is, in many cases, based on its
interactions with the IRS. If IRS does not
continue to improve accountability for its
financial operations, its credibility could be
diminished, reducing voluntary compliance by


42

on a more real time basis, there is hope that some of it will be
more immediately useable. It will not be valid until all of it is put
into the computerized system. But, if sufficient amounts of data are
put into the system fast enough, some early indications can be ob-
tained. I think that is the real hope with having the computerized
data entry system. That is why we think it is very important.

Mr. HANCcockK. In your compliance investigations, Mr. Brand, do
you find that where you get into some particular area that the tax
preparers are involved from the standpoint of merely giving incor-
rect advice to the income-tax payer?

Mr. BRAND. It is one of the things that we will attempt to deter-
mine with this particular TCMP. In response to a question of the
chair earlier, Ms. Stathis has referenced that we are looking at the
causes of noncompliance as we go through the examination process.
That is one of the areas we want to look at.

We do know from our compliance programs that you tend to find
more changes in returns where the taxpayers are represented.
However, those returns also tend to be more complex and there is
more tax planning, so it is hard to read a conclusion. I would not
want to draw the conclusion that there is a cause and effect. I sus-
pect you would find it in some instances. It is going to be depend-
ent on the individual practitioners, but I believe the complexity of
tax returns also enters into it.

Mr. Hancock. Thank you.

Chairman JOHNSON. Mr. Brand, just to follow up briefly, you ex-
pressed some concern earlier, as did Ms. Stathis, as to whether or
not all of your revenue agents would have adequate computer capa-
bility as they move forward in this audit. My understanding is that
you need about $1.7 million to provide the necessary equipment. In
the context of a $550 million program, and considering that the
success of the computer aspects of the program will determine the
timeliness of the information, are you going to be able to find the
$1.7 million?

Mr. BRAND. Whether we find the $1.7 million or whether we di-
vert computers from other parts of our operation, we will do this
in an automated manner.

Chairman JOHNSON. So you have no question in your mind but
that all of the agents participating in this audit program will have
good solid computer capability?

Mr. BRAND. We will have the ability to load this data in auto-
mated format and be able to analyze in an automated way.

Chairman JOHNSON. Given that fact, can you tell us when this
subcommittee could expect a broad outline of your findings?

Mr. BRAND. I believe that you have asked—as I recall, there has
been some discussion, Madam Chairman—about us providing re-
ports to you on a periodic basis. We will be more than happy to
provide reports as we go through the process of TCMP as to its
progress and what we find preliminarily as we go through the proc-

ess.

The thing that I want to say, though, is that what we are driving
for is statistical validity so we can use this for the basis of selection
of work and for recommended changes. So what we want to make
sure is, whatever we provide, we are going to provide with the


73

For all their faults, the TCMP results permitted me to
provide credible answers to those two questions. For one thing,

taxpayers could identify with the method for obtaining tho:

results, an IRS audit. The TCMP method was not some abstract
statistical, economic or social science theory. Taxpayers could
understand the idea of using a statistical sample of in-depth IRS
audits to determine the levels of reported and unreported income,
of appropriate and inappropriate deductions and credits. Taxpayers
also could understand the concept of using the TCMP results to set
standards for future selection of returns for audit and to estimate
the dollar amount of tax noncompliance by individual taxpayers.
There are many shortcomings of the TCMP. They have been

detailed in other testimony and will not be repeated by me he:

However, no one has come up with a better overall, comprehensive,
credible approach to provide answers to the above two important
questions that everyone wants to know about our tax system. And
make no mistake abut it, your constituents will want answers to
these questions, just as you and your colleagues in Congress will
want answers

From personal experience I can tell you that your
predecessors wanted answers to these two questions from me while I
was Commissioner. And your predecessors were not satisfied with
anecdotal responses, partial results from new and unproven tests,
theories about how to improve tax compliance, or promises about
what new long-term research studies would eventually provide.

Also make no mistake in believing that your predeci

ors
were unaware of the defects in the TCMP results. On the contrary,
the defects were pointed out, often painfully so for me and others
at IRS. Promises were made to improve the TCMP, and steps were
taken to do so. However, we did not propose to abandon the "known
devil" in favor of some “unknown devil."

Yes, the 1994 TCMP will be expensive for the government.
In part, however, that is a function of the fact that the new TCMP
will provide baseline data for the new approach to the new IRS
compliance program called Market Segment Specialization Program,
which I believe is the right approach for IRS to be taking in the
compliance area. As I understand it, future TCMP-type data will be

gathered less expensively.


82

Mr. Gipps. Again, Madam Chairman, I just want to make the
point that if we can get a consensus, a broad-based consensus
about something that is comprehensive and credible, fine. But until
we have that, we should not abandon what we have in favor of the
Pig in the poke.

hairman JOHNSON. I appreciate your comments, Mr. Gibbs.

Dr. Sparrow.

Mr. Sparrow. Madam Chairman, I think you raise a very impor-
tant question on the subject of the cash-based businesses, the un-
derground economy, and particularly nonfilers. Central to the Com-
pliance 2000 philosophy is certainly the idea that every kind of
noncompliance would be systematically and intelligently studied
and then remedies sought. So certainly the IRS should be paying
an awful lot of attention to problems that they cannot see through
their own internal data.

Now, the specific area that you raise is a very peculiar kind of
noncompliance problem. I think nonfilers have always been for
many years the IRS’ No. 1 compliance problem. If the IRS asked
itself what program do we have in place to deal with nonfilers, the
answers for many years has been “virtually nothing” because we
deal with what comes to us. What data do we have about nonfilers
in our data base? Absolutely nothing, not one bit or byte, because
they did not file. So this particular problem is an extremely dif-
ficult one to get at and to study and requires you to go to outside
sources, rather than inside sources.

In looking for signs of concentrations of a cash economy or
undeclared income, divide that into two categories: undeclared in-
come and unreported income for people that file and undeclared in-
come for nonfilers. The nonfilers really does require the IRS to go
to outside sources of data, just as they would, for instance, have to
look at the Yellow Pages of the telephone directory and see which
of these businesses that are advertising have not filed and compare
that with their own records.

The TCMP data in some sense could help with that form of anal-
ysis, though. Suppose you are interested to know what proportion
of the jewelry trade in the Los Angeles area did not appear to file
tax returns. One way of doing that is to have a representative sam-
ple of the ones that did file, to be able to extrapolate by some guess
as to how many of them you think there are, and to compare that
with external economic indications as to how much revenue this
business generates. But it would necessarily have to involve the
comparison of internal TCMP data to some other external source
which is less traditional for IRS to rely on.

With respect to filers who do not declare their revenue, I just
went through a line-by-line IRS audit and was actually quite im-
pressed with the way that it was approached. I had my pile of
records on the table, and for at least the first 142 hours the exam-
iner was not the least bit interested in those. Instead, it was an
asset-based approach. She was asking me what I earned, would I
show her and tell her about any houses or cars. Then she worked
back from that to see whether it appeared to match the income
that I had reported.

Even though what she ended up doing was a line-by-line—she
wanted to know how I arrived at every figure—there was also room


TAXPAYER COMPLIANCE MEASUREMENT
PROGRAM

HEARING

BEFORE THE

SUBCOMMITTEE ON OVERSIGHT

OF THE

COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES

ONE HUNDRED FOURTH CONGRESS
FIRST SESSION

JULY 18, 1995

Serial 104-30

Printed for the use of the Committee on Ways and Means

ee

U.S. GOVERNMENT PRINTING OFFICE
20-681 CC WASHINGTON : 1996

For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 20402
ISBN 0-16-052358-3

3


108

Mr. PoRTMAN. The question, I guess, for us today is what does
all this mean for TCMP? Will it be any different? I do not under-
stand what the differences might be. I think you are still going to
have a number of these kinds of cases. Although I suppose change
of address would not be as big a problem because someone will
have sat down face to face with an auditor.

Mr. LANE. Yes. I do not know that anybody keeps separate data
on what percentage of TCMPs settle out in appeals. I would imag-
ine that it is going to be fairly consistent with regular audits.

Mr. PorRTMAN. Ms. Smith, a couple of quick questions for you
since you have been through the process, I understand. I am sorry
T missed hearing your testimony firsthand, but you said that you
had pretty good records when you went through this process and
you were able to provide the information perhaps better than some
of us who are not as good at recordkeeping.

If you had come upon a situation where you did know factually
that you had properly done something and yet, you did not have
the marriage license or you did not have the title to the riding
lawnmower or whatever it was. You had the choice of fighting it,
Meaning going out and hiring a professional advisor, probably an
accountant, or just going along with it. What would have gone
through your mind?

I mean what I am trying to get at is the problem I think which
would occur in many cases where someone would say, do I go out.
and hire an accountant for $500 or $1,000 to try to resolve this
thing, or do I just pay the $700 or $800? .

Ms. SMITH. I went through much that same process a few
months ago when I got a speeding ticket and I had to decide how
much I wanted to spend. Whether I wanted to just pay the fine,
it was not a big speeding ticket, or hire a lawyer and go to court
and try to get the record erased or reduced in some way.

I think I would use the same standards for this. It would depend
upon the circumstances and I think it would come down to a dollar
amount, in large part. I am a stubborn person and if I knew I was
right and if I thought I had some way of showing I was right, I
would probably go forward more than a lot of people would choose
to do.

If there were very much money involved, I would feel the need
to go forward. If it were a minor point, like the argument I am hav-
ing with an insurance company now for $58, the stress is not worth
it. I am going to give up after about 1 hour.

Mr. PORTMAN. You might throw in the towel. Well, that is some-
thing that is an interesting part of the whole calculation of what
the cost is and the burden is on the taxpayer. I appreciate your tes-
timony.

I have one final question for Mr. Lane. This just goes to a projec-
tion of what the total cost to the taxpayer would be, by that, I
mean the Federal Government. I had heard some figures earlier,
and I think I had mentioned in my questioning that it seemed like
it was $300 to $500 million. You have talked about $2.1 billion
which includes kind of the lost opportunity costs, plus the actual
costs. Is that something that there is a consensus on among your
colleagues and those who understand the system pretty well?


131

Hearing on
‘The Taxpayer Compliance Measurement Program

Subcommittee on Oversight
‘Committee on Ways and Means
House of Representative

‘Statement of Kent W. Smith
American Bar Foundation
uly 18, 1995

Madam Chairman and Members of the Subcommittee:

1 am pleased to be here today to discuss the Internal Revenue Service’s Taxpayer Compli-
ance Measurement Program (TCMP). I am speaking as an individual social science re-
searcher, and my comments do not necessarily reflect the views of the American Bar Founda-
tion, In my research on tax compliance and administration, I have used TCMP data both in
the tabular form made publicly available by the Service and through special computer analyses
prepared for me by the staff of the IRS Research Division. My comments are also informed
by research on state individual income tax audits that I and my colleagues at the American Bar
Foundation and Oregon State University have done in cooperation with the Oregon Depart-
ment of Revenue (DOR). Many of the audits conducted by the Oregon DOR are general au-
dits whose coverage and thoroughness is similar to that for TCMP audits. For a sample of
these audits I have read hundreds of the auditors’ working papers, and we have interviewed
taxpayers about their responses to the audit process.

The TCMP is an invaluable tool for identifying and analyzing patterns of noncompliance
and for evaluating administrative and legislative responses. While I will later outline some of
the ways that I think TCMP could be improved, I begin by providing some examples of how
the TCMP data have been successfully used in analyses of tax compliance. I will then detail
some of the essential characteristics of the TCMP that contribute to its utility. My examples
are illustrative rather than exhaustive, and others testifying today have extensively used
TCMP data and can provide additional examples of the utility and limitations of the data. In
his recent article on the TCMP, George Guttman has described several other successful uses.
of the TCMP data by the Service and other government offices.”

Some Examples of TCMP Analyses

‘One of the particular strengths of TCMP data is that they provide a detailed picture of
patterns of compliance and noncompliance within a return. Rather than characterizing tax-
payers as simply compliant or noncompliant, the detail reveals on which aspects of the tax
return various types of taxpayers are more or less compliant. For instance, in our research for
the American Bar Associations Commission on Taxpayer Compliance, we used TCMP data
to obtain distributional information about compliance with line items. What aspects of tax
reporting are particularly problematic? For a particular line item, are there many taxpayers in
noncompliance by small amounts, or are there a few with large levels of noncompliance?
Either a lot of litte fish or a few big ones could produce the same aggregate level of dollar
noncompliance, but the difference between the two patterns has large implications for re-
source allocation and compliance strategies. As Susan Long has also pointed out, the detailed
picture of over-compliance also provides a very useful window into the level of unintentional

1, Two relevant papers are Stalans, Loretta J., and Karyl A. Kinsey (1994), “Self-Presen-
tation and Legal Socialization in Society: Available Messages about Personal Tax Audits,”
Law & Society Review 28: 859-95; and Smith, Kent W. (1995), “The Cultural Grounding of
Tax Issues: Insights from Tax Audits,” Law & Society Review 29: 201-38.

2. Guttman, George (1995), “Taxpayer Compliance Measurement Program: Is it Neces-
sary?” Tax Notes, June 5, pages 1282-88.




109

Mr. LaNE. I took that from the testimony, the printed transcripts
of Mr. Brand’s testimony today.

Mr. PorTMAN. Just adding it up?

Mr. LANE. He said it is $559 million direct costs and $1.5 lost
opportunity costs. That adds up to about $2.1 billion. There are
some interesting things in the testimony this morning, and that
was one of them that just caught my eye.

Mr. PorRTMAN. It is a big number when you compare that to other
things we are trying to do with tax modernization or any of the
other programs we have ongoing to try to make the system work
better and more efficiently. That is a substantial part of what we
have available to try to make ours work better. So that is interest-

ing.

Ser. LANE. I guess I look at that and look at the success they
have gotten from the market segment program and think boy, the
$2.1 billion could be better spent on other things in the market seg-
ment area in terms of taxpayer compliance.

I think the key thing with any of these things we try to do in
tax administration—and having spent 10 years in the Service in
the beginning of my career and now 15 years in private practice—
I feel qualified to comment that I think the key thing the Service
needs to focus on is the impact. In an ideal environment they
would only be working cases that deserve to be audited, enforcing
against people who deserve to be seized, and the taxpayers who
complied basically would be left alone.

That would be an ideal environment. The taxpayer who never
needed to be audited, never got audited. There are imperfections in
the system—as Fred Goldberg talked about; for example, the cir-
cularity issue. Just to keep doing it because we have always done
it that way, when we have got new tools available is wrong. I mean
what have we spent on technology in the last 5 years in IRS? We
should be able to come up with a better way of constructing a
method of sorting tax returns than to go back to a model of some-
thing we used in 1963.

I am also concerned about some of the assumptions that IRS
draws from the data. For example, in Mr. Brand’s testimony today,
there is an assumption about what impact they had in compliance
as a result of the child care issue.

You have a chance to review that. Our take on that is 180 de-
grees the other way. I do not believe, as he points out in his testi-
mony, that they identified a problem with People overstating the
credit and so they required the tax ID number of the child care pro-
vider. As a result, 2.7 million taxpayers stopped claiming the credit
which gave them an additional $1.2 billion in revenues, and credits
that to the TCMP process.

I do tax returns, folks. There is no way that 2.7 million people
were claiming a fraudulent credit and stopped taking it because
now they had to put the tax ID number of the child care provider
down. That is not what happened here. Rather, what happened is
because they had to put the tax ID number of the child care pro-
vider down, they had to make a decision: “Was it worth turning
grandma in for the $480 credit?”

The 2.7 million people made the decision that for $40 a month,
it was not worth disrupting their baby sitting situation. That is


APPENDIX II APPENDIX IT
Table Marl egments and Sample Sizes for IRS
S-corporations
Market Sample size
segment Percent
Population | Form AlL that are
Market _segment (000) 1120ss_| returns | 1120ss
Finance and insurance 68 s98| 4,040 14.8
Air, bus, and taxi n 599| 2,805 21.4
Other transportation 64 59¢| 3,703 16.0
and utilities
Amusement , 52 594] 3,671 16.2
recreation, and
motion pictures
Medical and health 74 595| 5,034 11.8
Business and personal 244 593| 6,144 9.7
Hotel, lodging, 78 593] 5,473 10.8
automotive
Unable to classify 32 595 | 15,317
Miscellaneous Not o| 2,382 .
business and personal | available
services
Other miscellaneous 139 598] 5,496 10.9
services
Total® 1,815 | 12,501] 152,534 8.2

“Totals may not add due to rounding.

Source: Final 1994 TCMP Sample Design.


89

my papers. Had my company been less helpful, that would have
been a most painful expense.

I clearly remember standing outside that storage room looking at
a floor-to-ceiling collection of boxes, and I think every one of them
was labeled “household stuff.” I dug in and eventually toward the
back found the box with my old personal records.

That was the easy part. My W-2 and interest statements and so
forth were there with the return. But I cannot estimate how many
hours I spent pulling together the bank records. I remember the
IRS wanted more than 12 months of bank statements. I recall it
covered at least parts of 3 years.

So I had to sort through my checking account records to see how
many statements I had in hand. Then I had to go to the bank and
order reprints of those I was missing. I had to pay a small fee for
each of the statements. Then I had to go through the bank state-
ments and make sure I could defend or explain each deposit. I did
not worry over the small $5 ones, but my travel reimbursements
were sometimes substantial. Also, sportswriters often freelance,
and I knew I had to show that I declared all my earnings.

I spent at least one afternoon at the newspaper getting copies of
my reimbursement records. Eventually, I had everything explained
except for one $1,500 deposit. I could not find any record of where
the money had come from. I finally told my accountant that I was
worried about it, and he pointed out that it was my tax refund
from the previous year.

I did not have to go to the audit myself. The auditor said my ac-
countant could probably answer all his questions, and this saved
me a trip to Jackson. I do not believe I paid the accountant extra.
I had paid him to prepare the return, and also I had done all the
work in gathering the documentation. But I would have paid him,
if necessary, just so I would not have to sit and watch while my
financial life was strip-searched.

My accountant called later that day to say that the auditor had
seemed pleased with all the documentation and did not think there
would be any change to my return. My accountant said this was
probably the best audit he had ever participated in. He said the
auditor was professional and pleasant and covered the ground
quickly.

A few weeks later, I received this letter in the mail. It said: “We
are pleased to tell you that our examination of your tax returns for
the above periods shows no change is necessary in your reported
tax.” Suddenly the whole experience was worth the trouble. I had
survived the adventure. But more importantly to me, I had done
my part as a citizen of this country. I had filed my return, I had
paid the lawful amount of tax and I could prove it.

There have to be audits, and this means that citizens get singled
out even if they have done nothing wrong, not unlike jury duty. I
hope I never have to do it again. It cost me quite a bit of time and
a small amount of money. But I have never been sorry that the
computer spit out my name.

Thank you.

Mr. HaNcock. Thank you.

Mr. Lane.


84

Mr. LAUGHLIN. Certainly, if it gets beyond $1,000 or so, it cer-
tainly takes on the approach of an unfunded mandate that has
been on the minds of a lot of Americans the last few years in just
dealing with their real property and other activities, so I share the
concern that you mention there.

Would you have such a concern on the intrusion to obtain the in-
formation, if the IRS were paying the taxpayer for his or her time
to come and sit through the compliance audit to determine where
the gaps are?

Mr. GOLDBERG. Well, that would recompense the taxpayer for the
out-of-pocket costs. I am not sure it recompenses the taxpayer for
the time, the pain, and the suffering. But I think that that would
be an important first step to take.

Mr. LAUGHLIN. You have also indicated that nothing new would
be learned about the overall tax gap and its major components. The
TCMP design calls for measurement of the compliance by market.
segments. Do you not think that a knowledge of which groups of
taxpayers are contributing to the tax gap would be valuable?

Mr. GoLpBERc. I believe that the market segment approach to
tax administration is the single most promising development in a
decade. I think Dr. Sparrow’s reference to Compliance 2000 was an
issue I had some involvement with. I think that is breakthrough
progress in tax administration.

What I am saying is that the 1994 TCMP as designed in my
judgment is trying to retrofit something to deal with these new is-
sues. I believe you could deal with those new issues far more effec-
tively if you simply say I want to design a program to deal with
those new issues. I think we are trying to make something that
used to be useful serve a very different purpose, and I do not think
they are going to get there as well as they should get there. I agree
with market segments, absolutely.

Mr. LAUGHLIN. Thank you very much. Thank you, Mr. Chairman.

Mr. HANCOCK. That was an interesting comment you made, com-
pensating the taxpayer for the pain and suffering. I do not know
whether that could be done or not.

Is it possible—and I would like to ask all three this question—
we were seriously considering major changes in the tax law in this
country, the possibility of a consumption tax or a flat tax. Can we
justify the TCMP on a basis of what we do maybe here in the U.S.
Congress in the 105th Congress for at least data information, the
compliance information on how the existing tax law ought to be
changed, or what we need to do if in fact we change it?

Mr. Sparrow. Certainly, if there is a looming and major change
in the tax law, then it makes this less attractive at this time right
now, but I would make two qualifying points.

Even if change is coming, then somebody is going to be doing an
awful lot of thinking about sensible changes in tax policy, what are
the areas of tax administration that cause taxpayers difficulty,
which are the areas that are poorly understood, what are the prin-
cipal forms of noncompliance under the existing system. I do not
believe that the IRS, having not done a TCMP survey since 1988,
really has up-to-date information of that kind on which it could
soundly base recommendations as to tax policy changes.


12

Chairman JOHNSON. Thank you, Mr. Brand.
Ms. Stathis.

STATEMENT OF JENNIE S. STATHIS, DIRECTOR, TAX POLICY
AND ADMINISTRATION ISSUES, GENERAL GOVERNMENT
DIVISION, U.S. GENERAL ACCOUNTING OFFICE

Ms. STATHIS. Thank you, Madam Chairman.

We are pleased to be here today, Madam Chairman, and mem-
bers of the subcommittee. To my left is Ralph Block. He is an As-
sistant Director in our San Francisco office, who is our person re-
sponsible for doing most of our studies of TCMP.

I will summarize my statement and submit it for the record if
I might.

Sound tax policy and administration decisions depend on com-
prehensive, reliable, and timely information on taxpayer compli-
ance. For about 30 years the Taxpayer Compliance Measurement
Program has been IRS’ primary program for gathering such infor-
mation. TCMP is unique. Of all the various methodologies that IRS
has, it is the only one that gives a statistically reliable indication
of nationwide compliance with the Federal Tax Code.

IRS also uses TCMP data to estimate the tax gap, to identify
compliance issues, to develop formulas for objectively selecting re-
turns to audit, and to allocate audit resources. Congress and Fed-
eral and State agencies rely on this data for policy analysis, for
revenue estimating, and for research.

In 1991 IRS proposed a much smaller TCMP because of criti-
cisms that it was too costly, too intrusive, and too untimely. We re-
ported in 1993 that the proposed changes would reduce the TCMP’s
usefulness and that the criticisms did not justify such a major
modification.

We concluded that the additional revenues generated because of
tax law and administrative changes resulting from TCMP analyses
had far exceeded the costs. TCMP audits may be intrusive but they
affect relatively few taxpayers and they help many others avoid an
IRS audit. While timeliness is of concern, we concluded that IRS
could speed up its analysis of TCMP data if, for example, it vali-
dated data earlier in the process.

IRS is getting ready to conduct the most comprehensive TCMP
ever undertaken. Currently planned to begin in November, it will
include about 153,000 returns of individuals, partnerships, S cor-
porations, and small corporations.

In comparison to past surveys, the upcoming TCMP should pro-
vide IRS auditors with more information and better tools with
which to perform more efficient, more effective audits. IRS hopes
to collect data for the first time on the reasons for noncompliance
and on the particular tax issues involved.


General Program Cases Cases Total Cases | Percentage of
Forwarded to Cisd lie
‘Appeals otal
Individual 14,931 239,145 8%
Corporate & Other 13,094 100,420 13%
Coordinated Exam Program 4,101 4817 23%,
init 160 22,822 1%
Total 29,286 367,204 8%.

Question 2: What percentage of those cases result in a reduction of the
taxpayer's liability?

Answer: The Appeals function accounts for reduction in the taxpayer's liability using
the total tax deficiency and does not maintain statistics by the number of cases. Of the
eight (8) percent of cases forwarded to Appeals from October 1994 through June 1995,
the total deficiency was reduced by 71%.

(dollars in thousands) | Total Cases | Revenue Agent | Tax Auditor
Proposed Deficiency $5,586,499 $5,404,264 $182,295
Revised Deficiency $1,622,141 $1,556,271 $65,870)
Percentage Reduced

Defi 71% 71% 64%

Question 3: How many individual and corporate returns included in the last
CMP surveys were forwarded to Appeals?

Answer: In the most recent TCMP survey of individuals (Form 1040 filers) 863 of the
54,088 taxpayers, or 1.6%, appealed the results of their audit. In the most recent
TCMP survey of corporations (Form 1120 filers) 746 of the 18,138 taxpayers, or 4.1%,
appealed the results of their audit.

Cases
TCMP Survey Forwardedto | Tia) Cases | Percentage of
Appeals ota
1988 Survey of Individuals 863 54,088 1.6%
1987 Survey of Businesses 746 18.438 4.1%



96

Mr. Hancock. Thank you for your testimony. All three of your
written statements will be entered into the record.
Mr. Keating.

STATEMENT OF DAVID L. KEATING, PRESIDENT, NATIONAL
TAXPAYERS UNION FOUNDATION

Mr. KEATING. I appreciate the opportunity to testify today. I rep-
resent the National jexpayers Union Foundation. My name is
David Keating. I would like to touch on something not yet heard
in today’s hearing that I picked up from our advisors when I can-
vassed them for suggestions about this program. That is, does the
TCMP have a garbage-in/garbage-out problem, and how serious is
it?

A recent article in Tax Notes, by George Guttman—who I believe
is in the audience—says TCMP data reflects selected audit results
only, and no subsequent change is made when a taxpayer success-
fully contests an adjustment with the IRS appeals office or through
litigation. Overall, the maintenance rate for issues that go to ap-
peals and litigation is no more than 50 cents on the dollar.

Something else that I learned that was quite disturbing to me is
that the people in the appeals office have, I think, different stand-
ards that they are held to than the tax auditors. If you look at rule
one, governing practice before the appeals office, it says, “It shall
be his or her duty’—meaning an appeals officer—“to determine the
correct amount of tax with strict impartiality as between the tax-
payer and the government and without favoritism or discrimination
as between taxpayers.”

Now, given the enormous amount of criticism of tax auditors by
GAO and others, and the discrepancy between findings at the au-
diting level and the appeals level, I wonder how much statistical
noise we are introducing into the TCMP data by not holding these
auditors to the guidelines or professional standards we expect for
employees of the appeals office.

I also picked up concerns about the timing of this TCMP. You
would have to have your head buried in the sand not to realize that
politically a lot of changes have happened in the last few months,
and I think there is probably the best chance we have ever seen
since the adoption of the income tax, over 80 years ago, to actually
replace it with something brand new.

The IRS is essentially proposing to put all its statistical eggs in
one basket, meaning the 1994 return, which may be one of the last
returns under the current income tax law. I would think they
would want to put their eggs in more baskets.

Another thing that is very important to our members and others
is that it can be extremely expensive to face a TCMP audit. For a
small businessperson, the cost can be quite punitive. I notice that
in some of the stratifications of the samples, it would not be un-
common for 1 in 100 or even 1 in 200 taxpayers in some small busi-
ness areas to be selected for audit under TCMP. That is a rather
large number of people, especially when you compare it to other au-
diting rates in the population.

Now, the IRS in designing this TCMP project is pretending there
is no cost for the taxpayer’s time and expense in hiring a profes-
sional. That is uneconomic for the country. The IRS has little in-


75

Chairman JOHNSON. Thank you, Mr. Gibbs.
Dr. Sparrow, welcome.

STATEMENT OF MALCOLM K. SPARROW, PH.D., LECTURER,
PUBLIC POLICY, JOHN F. KENNEDY SCHOOL OF GOVERN-
MENT, HARVARD UNIVERSITY, CAMBRIDGE, MASS.

Mr. Sparrow. Thank you.

Madam Chairman and members of the subcommittee, I thank
you for letting me be a part of this discussion this morning. In
some ways, this discussion is part of a broader discussion about the
policies of regulatory agencies, and the broader question would be
should regulatory agencies be allowed to do random inspections of
any kind? Should Customs be allowed to select passengers at ran-
dom as they come through the airport in their attempts to under-
stand patterns and methods of drug smuggling? Should OSHA in-
spectors be allowed to show up unannounced at a construction site
where there has been no report of hazards, but they go on a ran-
dom basis just to find out what kind of hazards are there?

I believe that regulatory agencies should be allowed to do ran-
dom inspections and that it is vital, if they are going to understand
patterns of noncompliance. For the last 6 years, I have been study-
ing and writing about some of the changes in the strategies of
American regulatory agencies, and there is a very significant move-
ment under way and the IRS is party to that movement.

The movement I think is an attempt to discover a more intel-
ligent, a more analytical approach to identifying patterns of non-
compliance and then picking them apart, understanding where
they come from and bringing a broad range of different tools to
bear on identified patterns of noncompliance.

At its heart, this strategy is designed to be less coercive, to rely
much less on traditional enforcement approaches and to consider,
instead, a much broader range of intervention tools, including edu-
cation, legislative changes, simplification, education programs of
various kinds, as well as the normal ragbag of audit and enforce-
ment tools.

Police departments call this problem-solving policing. Environ-
mental protection agencies call it managing for environmental re-
sults. OSHA is now calling it the problem-solving approach to haz-
ard mitigation. The IRS calls it their Compliance 2000 strategy.

Now, what is at the heart of the Compliance 2000 strategy, if I
understand it correctly, is an intention to develop the capacity to
identify important areas of tax noncompliance and then produce
tailor-made surgical interventions aimed at producing higher levels
of compliance, and to do that problem-area by problem-area. That
is the heart of the strategy and it is still under development. It is
certainly not fully implemented. It is a much more analytical, more
intelligent, and less enforcement oriented approach to taxpayer
compliance, which I think we should all recognize and welcome.

But such a strategy depends absolutely on the agency’s ability to
see clearly patterns of noncompliance and to recognize when they
change, and to recognize it sooner, rather than later. An important
question to ask is what apparatus is there available to the IRS to
enable it to see changing or shifting patterns of noncompliance? I


36

In doing those audits, have you been able to find any ways to get
at other sources of income that are not. being reported?

Mr. BRAND. Well, the audit techniques that we do will, in fact,
allow us to make various judgments as to additional unreported in-
come. As you f°. into the examination process, basically when you
do the preanalysis of the income tax return, you begin to look at
various different reasons that there may be unreported income and
there are various different audit techniques that you apply that.
will, in fact, reveal unreported income.

Then you have to determine——

Chairman JOHNSON. Considering the dimensions of this problem,
I do not hear your citing examples of changes in the law that have
been made to better reach this income. But this is kind of a tan-
gential issue and I am going to yield to my colleagues so that we
can move along.

Mr. Zimmer.

Mr. ZIMMER. Thank you, Madam Chairman.

Mr. Brand, I would ¥Ke to know some of the practical impact of
your program. In a hypothetical situation, if a working couple with
two children and a combined income of between $30,000 and
$50,000 is selected for the TCMP, how long will it take them, on
average, to complete the audit?

Mr. BRAND. That is going to be dependent, of course, on what
records they have available and so forth. If you are assuming that
they are wage earners, and that their deductions are basically ei-
ther standard deductions with some dependents or else it is a
schedule A that has relatively small amounts of deductions and so
forth. An audit like that with the records available should take on
average 142 hours to complete.

It gets more complex, obviously, as you get into other areas.

Mr. ZIMMER. Well, how often are the records not available in
your experience?

Mr. BRAND. It depends on the individual taxpayer and their rec-
ordkeeping.

Mr. ZIMMER. Well, we are talking about the average. For in-
stance, I do not know if I could find my marriage license and—

Mr. BRAND. I cannot give you that estimate, Mr. Zimmer.

Ms. SraTuis. I do know that from the last TCMP the average
amount of time that the IRS auditors spent on an individual’s re-
turn was 13 hours. But that——

Mr. Zimmer. Is that with the individual?

Ms. STATHIS [continuing]. That is the auditor’s entire time, be-
ginning with preparation. The amount of time they would spend
with the taxpayer would be a subset of that.

Mr. BRAND. From a scheduling standpoint for interviews, an ex-
amination of a nonbusiness individual return most likely would be
done within the office. From a scheduling standpoint, we are nor-
mally scheduling four to five examinations a day; three to four in
a situation if TCMP is what we are trying to do.

That allows our examiners to complete workpapers, an audit re-
port, and the TCMP checksheet.

Mr. ZIMMER. Now, does the audit take place during normal busi-
ness hours?

Mr. BRAND. Yes, sir.


48

themselves are often paper files. In fact, they are workpapers and
it becomes more difficult to extract that.

What we want to do, and this is the whole heart of this process,
what we are after is a methodology that would help us measure
compliance and select workload in a way that is the least intrusive
to the taxpayer and is the most efficient in revenue yield for us and
for the government. Whatever we can do, we are open to sugges-
tions on anything that we can basically do that will help us balance
this particular process. So we accept the suggestions of the GAO
and will try to act on them, yes, sir.

Mr. HERGER. Thank you.

You indicated that you will be including samples of partnership
and S corporation returns in the sample. Will the issues be fol-
lowed through to the partner and stockholder returns to measure
the tax impact?

Mr. BRAND. Yes, we do what we call pickups on various examina-
tions. In fact, dependent again on what we find, we may go through
and do the pickups and follow up with adjustments. We do those
on regular examinations, too, if we get into a partnership return.

Mr. HERGER. Ms. Stathis, if we could return to an earlier ques-
tion of how far back we would be going. I think we are shooting
for 3 years, but I believe I heard you mention 1988 and back to
1981. Would you mind commenting on that?

Ms. Status. Mr. Hancock’s point is that the data is old by the
time they are available, 3 or 4 years out of date, and I was explain-
ing to him that because the TCMP of partnerships, for example,
has not been done since the 1981 tax returns, the data currently
available is old.

We are in 1995, so the partnership data is 14 years old. We know
that enormous changes have taken place in partnerships over that
many years. So the TCMP data that is available to think about al-
ternative changes to the tax system and how that might affect
partnerships are very unreliable at this point.

Mr. HERGER. Very good. Thank you.

Chairman JOHNSON. Thank you. Mr. Levin.

Mr. LEvIN. Thank you.

Iam sure I missed the earlier part of the hearing and your open-
ing statements. As I went over the materials yesterday, I really
was not clear, is the purpose of the hearing this morning kind of
a traditional oversight hearing, or is there some contemplation of
legislation that would alter the planned reinstitution of the pro-
gram? I am not quite sure what our purpose is here this morning.

Chairman JOHNSON. Our purpose is to hear in more detail the
IRS’ plans for this audit. There has been some significant criticism
of the TCMP, and were we to determine that that criticism was
overwhelming, that the program ought to be canceled, we might
want to do that.

The initial materials and testimony raised those questions, but
certainly no one on the subcommittee to my knowledge has made
any judgment that that might be the right thing to do. I think,
more importantly, there are some ways in which the burden on the
taxpayer might be alleviated. There are some ways in which the
data might be gathered in a more timely fashion and reported to


117

In these tight budgetary times, I believe that one way that more
could be gotten out of TCMP is by making TCMP microdata files
available for analysis outside the agency. This would in no way im-
pinge on individual taxpayer privacy.

For many years IRS has sanitized microdata files from its statis-
tics of income programs and made them publicly available. Al-
though IRS has argued that access to ‘MP microdata would
somehow impair its collections strategies, these fears are largely
misplaced.

There is no reason not to release historical files. For more cur-
rent data there are numerous approaches that could be adopted to
meet IRS concerns while still allowing broad access.

The third and final point I wanted to turn to is the issue of tax-
payer burdens. It has been suggested in some quarters that TCMP
is a burden for the taxpayers that are selected for this special
audit. Of course, this is true. In a similar way serving on a jury
is a burden, sometimes a big one, but being judged by a jury of
one’s peers improves the chances of a fair system for all. & it is
with TCMP, the existence of which can lead to a more equitable
and efficient tax system for all.

Historically TCP has been used mostly for identifying ways to
modify the behavior of taxpayers. An equally important but
underutilized purpose should be to identify ways that the tax sys-
tem can be modified to help taxpayers meet their obligations with
the minimum administrative hassle.

Let us face it, a great deal of burden is imposed by our tax sys-
tem on all taxpayers. We should think creatively as to how we
could use information to eliminate some of these unnecessary has-
sles.

Two of these areas that occur to me are in the area of complexit;
of tax laws. First, we could use TCMP to assess just how muc
complexity leads to noncompliance. My written testimony goes into
that, and hopefully would allow Congress to better confront that
problem with real figures.

Second, we could use TCMP to provide us a window on IRS au-
dits and, therefore, to pinpoint areas where IRS auditors are rais-
ing inconsistent or unnecessary claims. I have a number of sugges-
tions as to how that might be achieved and, thereby, get the maxi-
mum leverage out of TCMP and in the long run reduce taxpayer
burdens.

Thank you.

[The prepared statement follows:]


53

Questions 2: The percentage of the audits in which taxpayers must be seen more
than once, more than twice.

Answer: Nearly 70 percent of individual retums examined in office examination are
closed after the first appointment; an additional 20 percent are closed after the second
appointment. Only 10 percent of all office examination cases require more than two
visits with tax auditors. For retums examined by revenue agents, 24 percent of cases

are closed after the second appointment, and 48 percent are closed after the fourth
appointment.

Question 3: An estimate of the average amount of time taxpayers expend on all
activities encompassed in their response to a TCMP audit, or in the alternative, a
number of representative case studies.

Answer: There is no direct measure of the total amount of time taxpayers expend in
the course of a general program or TCMP examination. The estimates computed in the
answer to Question 1 reflect the total time expended by revenue agents and tax
auditors during stages of the examination where taxpayer contact takes place.

Question 4: The estimated out-of-pocket cost to taxpayers.

Answer: The data from general program process measures indicates that 80 percent
of the taxpayers examined by tax auditors in office examination did not have
representation. Of the business retums examined by revenue agents in the field, nearly
60 percent were closed without representation. It is not possible to accurately estimate
the out-of-pocket costs expended by taxpayers in the course of a TCMP examination.

B. APPEALS
Question 1: In the normal audit program, what is the average number and
percentage of general program cases that are forwarded to Appeals?

Answer: For the period beginning October 1994 and ending June 1995, eight percent
of general program cases were forwarded to Appeals.


138

you do, I would never want to go below that but I would not nec-
essarily see that the value of going above that would be as great
as maintaining at that level.

Mr. LAUGHLIN. Dr. Smith, you indicated that the TCMP covers
answers to more questions than the IRS research division can ex-
plore. Would you recommend that sanitized data be made available
to outside researchers as well as to the district office research
sites?

Mr. Siu. I am an outside researcher, I would love to have the
data, but I think that the initial focus probably is on getting up to
speed more of the sites at the district level within the Service for
taking advantage of the data.

I would say that institutionally that should be the focus because
getting more people——.

Mr. LAUGHLIN. Well, let me just interrupt you and ask on that
point. You stated more needs to be done to get up to speed and I
take it you are talking about the TCMP process. What are your rec-
ommendations, specific recommendations for doing that?

Mr. SMITH. I am thinking about the analysis of it. At the DORA
level, the analyses could now be done with modern computers with
a reasonable level of training and data analysis. Even more critical,

erhaps, is also an understanding of the technical problems of ana-
if ‘ing data from audits. Presumably, IRS personnel have some of
that sensitivity.

Getting that ability out, at the district level in the new DORA
sites, could increase the understanding of approaching problems in
an analytical way throughout the Service. That would have a major
advantage.

Yes, there would be considerable advantage in getting more out-
side researchers interested in studying patterns of compliance and
noncompliance by giving out sanitized data. To extend just a bit on
what Dr. Long said, a recent study in last year’s Research Bulletin
from the IRS showed that a great deal of the ability of the DIF
process to identify targeted taxpayers for auditing is on how the
Service manipulates and prepares the data for the analyses. Out-
side researchers are not going to have that same skill. That skill
is based upon decades of working with the data.

Mr. LAUGHLIN. Well, I certainly thank this distinguished panel
of doctors for their appearance.

I yield back to the gentleman from Missouri, the chairman.

Mr. HANcock. The chairman would exercise his prerogative on
this and that is, Mr. Feinstein, were you stating in your statement.
that the average return without the DIF assessment was $1,000 or
whether it was $5,000? I do not know if that is a statement on how
good the auditors are or how bad the tax law is. But this hearing
is Adjourned, thank you.

ereupon, at 2:52 p.m., the hearing was adjourned.)
[Submissions for the record follow:]


49

us in a more timely fashion, so that we could make better use of
it.

Some of us are interested in whether or not we are looking in
the right place. This does not look at the underground economy,
and that is of concern. So there is a variety of issues that are ap-
propriate to this hearing. If the hearing material is overwhelmingly
critical and can demonstrate that there is no value to this program,
then this subcommittee would be forced to recommend to the full
committee that the program be dropped. I do not see that that is
the evidence of the hearing, but there will be people who will tes-
tify who believe that is the case.

So I would say that this was an oversight hearing in the best tra-
dition of oversight. On the other hand, it is a hearing from which
we would have to act promptly if we wanted to alter the course
planned by the executive branch.

Mr. Levin. At this point, there is no plan or——

Chairman JOHNSON. There is no preconceived plan of either leg-
islation or action that might come out of this hearing.

Mr. LEvIN [continuing]. In simple terms—and you probably have
already stated this—why have you done what poe are doing? Why
the reinstitution of the plan? y is this now being recommenced?

Mr. BRAND. We are concerned about the age of the data and also
the fact that over a period of time, as your data gets old, your no-
change rate starts to climb because of the fact that there is a
change in law, et cetera. It also helps us allocate our resources in
the areas where we can be most productive. It also helps us con-
firm what we believe from our examiners’ experience in the field.
Statistically, it helps us confirm that there are particular areas
that need legislative change. We would normally be doing TCMP
surveys on a more regular cycle.

The Service did enter into a policy debate around this with pre-
vious Commissioners over what should be the size of TCMP sur-
veys, what should be the TCMP process. I think Ms. Stathis has
testified previously to some of that particular debate. We reached
the point within the Service that we felt it was time to go ahead
with another TCMP. We wish to gain some additional information
as I talked about in terms of market segments and geographical
area sensitivity, and felt the time was right to do that.

Mr. LEVIN. & you think that this step is important in terms of
your audit program?

Mr. BRAND. It is important beyond the audit program, Mr. Levin.
The Service for the last 20 years has, through a combination of en-
forcement and voluntary compliance, collected about 87.5 percent of
what we estimate the annual tax base to be. We have been chal-
lenged, partially because of the economic situation of government,
to improve our collection of that tax base to at least 90 percent, a
3.5-percent increase.

We believe that moving toward understanding market segments,
being able to deal with market segments in a wholesale methodol-
ogy, information, education, negotiations, is a better methodolo;
than what we have done in the past, which have been specific
one-on-one examinations to deal with areas of noncompliance. We
think this is one of the most vital things we have, understanding


78

before.

Meanwhile new patterns of non-compliance emerge, some
geographicully concentrated, sone peculiar to particular industries,
some particular to certain tax-provisions; but all potentially out of
your sights. If you have no system or machinery to holp you spot new
problems, you may not notice them for many years. TCMP is a piece of
Bachinery designed specifically to help identify new arcaa of non-
compliance, which the IRS might otherwise remain oblivious to.

ToMP's strength, T believe, lies in its random selection. (the IRS
‘@ stratified random sampling technique to make sure that the
ch area and industry segment are large enough to
support proper statistical inferences). The whole point ie that the
selection is not focused on any existing problem, nor based on any
existing aks bi about where Lie important Peonsene might be. It
is designed ac s statistically valid, scientific method of scanning
the horizon ror new problems. It reveals to Lhe IRS what they don't
currently Xnow about patterns of non-compliance.

Random audits are usually as unpopular within a regulatory agency
as they are outgide. Auditors often think random audits (or
"studies") are a waste of time, saying they could raise a lot more
revenue if only they were allowed to focus on known problem aruas.
Which is true; they would raise more revenue that way.

t that arguaent misses the whole point. The principal value of
randon audits Sy the IRS (ere-for chat aactar--rangon inepactions. by
Customs, or random audits of health care claims) is that they provide
information about types of non-compliance which existing targeting
strategies might be tissing. They provide the opportunity, over the
long term, to redirect resources; to adjust audit selection rormulas;
to target examination and audit resources more effectively; and to
select enforcement actions that the greatest impact on
significant areas of non-compliance.

Any cost-benefit analysis of such a program has to weigh

importance of tne infermution about nonccspliance trends’ which Will
act as a basis for longer term planning and resource allocation,
rather than focusing on the immediate and direct revenue implications.

I understand that undergoing a thorough, line-by-line IRS audit
taka some time. I just vent through one myself. The IRS plans, I
believe, to audit roughly 92,000 individual returns in the Proposed
TCMP. Givan that there are more than 100 million individual filers,
and that TCMP comes around no more often than once every three years,
thie represents 9 risk of facing a random audit, per taxpayer, per
year, of less than 1 in 3,000. this, I believe, is s very small price

taxpayers to pay in exch for the assurance that the IRS will
to devote its considerable public resources to the most
Poportant non-complianca iasu

I regard TCMP ae an eaaantial instrunent for monitoring the
shifting patterns of non-compliance. Taking it away would blind the
IRS te changing patterng of non-compliance.


88

We will dispense with the preliminaries and get right on to
Ms. Smith,

STATEMENT OF VERENDA SMITH, ALEXANDRIA, VA.

Ms. Smiru. Mr. Hancock and subcommittee members, my name
is Verenda Smith and I live in Alexandria, Va. I have been asked
to ghare my experience with what I now know is called a TCMP
audit.

I have developed a personal definition of adventure. It is some-
thing that you wonder if you are going to survive. A TCMP audit
is unquestionably an adventure. To understand how the audit af-
fected my life, you have to know about my circumstances at the
time.

In the early eighties, I was working as a sports columnist at the
Jackson Clarion-Ledger in Jackson, Miss. I earned around $25,000.
I had a few stocks, and I owned a house. My tax situation was fair-
ly simple, but I used a CPA to prepare my return because he had
helped me in the year that I had sold a house.

In 1982 I was transferred to Virginia to help launch a new publi-
cation called USA Today. I was moving into a 400-square-foot
apartment, so most of my belongings went into a storage shed in
Jackson.

Now we jump ahead to January 28, 1983. I remember the date
clearly, because that was my birthday. Among my birthday cards
was a letter from the Internal Revenue Service telling me that 1
had been selected for an audit which would be at my house in
Jackson in about 10 days time.

At that point, I did not know anything about the nature of the
audit. I thought all audits were the same, and that if your return
was chosen, everything was scrutinized. I thought it was strange
that they would want to look at a simple return like mine, espe-
cially since I was anything but rich. One thing was clear, though,
this was a very extensive audit.

The letter told me that I would need bank statements, docu-
mentation to show the source of all my bank deposits, documents
to back up every item on the return, and, if I could, would I please
supply a copy of the return itself.

Thankfully, the letter also supplied the name and phone number
of my IRS auditor. I called immediately. I am pleased to report
that the auditor was great. He seemed to anticipate that I would
be confused, surprised and facing difficulties, and he was prepared
to help. The reason I can tell this story today and smile is because
he understood that I would need my hand held. He used humor
and judgment, and he did not treat me like a tax cheat, but, rather,
like a taxpayer.

He filled out his questionnaire while we were on the phone, and
there were dozens of questions, like what kind of car did I drive
and how much cash do I typically carry, questions that seem
geared toward determining whether my lifestyle fit my $25,000 sal-
ary. None of the questions were very personal, but some of them
were humorous.

We rescheduled the audit and arranged to have it at his office.
My employer invented a business trip to Jackson so I could gather


43

right cautionary note that it may not be valid at this particular
point in time.

Chairman JOHNSON. At this time, in looking at the plan that you
have laid out, would you estimate that we could have a pretty solid
report before us in 3 years?

ir. BRAND. Yes, ma’am.

Chairman JOHNSON. So we do not have to think in terms of the
5 years of the past?

Mr. BRAND. Again, when we talk about the analysis of the report,
I think we may be talking about two things. There is the TCMP
data itself. I believe the reports you may be referring to are the es-
timates that we do on the tax gee which is based on TCMP, but
then annually refreshed or refreshed when we do reports with
other economic data. We can provide those on a timely basis.

Chairman JOHNSON. We certainly will be interested in those, but
we will be more interested in the specific conclusions of the TCMP
and their policy implications. Ms. Stathis, do you have any con-
gems about the ability to provide us with a substantial report in

ears?

is. STATHIS. Not on the TCMP results. One of the things to keep
in mind is that the results of the TCMP are used long before the
tax gap studies are released. The TCMP results are going to be
used to update the selection formulas for identifying returns to
audit in the regular audit program. That has already been done
using 1988 TCMP results. In fact, updated formulas were used for
1993 tax returns. There are a variety of other uses made of TCMP
data long before the tax gap estimates are released.

Chairman JOHNSON. Is that data from which you can draw policy
implications that would be available earlier than 3 years?

Ms. STATHIS. Yes.

Chairman JOHNSON. My understanding is that you will not finish
the audits for the first 2 years, it will take them 2 years to go
through this.

Ms. STATHIS. Well, at the end of 3 years, IRS definitely should
have valid data. There will be points along the process when there
will be a sufficient sample of particular returns that will be valid
earlier than 3 years. Data may not be valid for other types of re-
turns until all results are put into the system, which may take 3
years.

If IRS were to get down to one line item on the return and there
were only a certain number of those returns filed, a very large
sample would have to be examined in order to obtain valid results.
But if the sample was stratified in certain ways, some kind of na-
tionwide sense of compliance problems could be obtained earlier.

We have done a variety of studies for Congress in which we have
been asked to study a particular issue. In doing them, IRS has al-
lowed us to use the old TCMP data. So, on a number of our studies
we have gone back in and used the 1988 TCMP workpapers and
data in order to analyze——

Chairman JOHNSON. Some of it is very old.

Ms. STATHIS . That is true but the point is the data is useable
way before IRS issues the tax gap report.

‘hairman JOHNSON. Mr. Portman.

Mr. PorTMAN. I thank the chair.


129

So a 3-year lag may be an inevitable consequence of this process.
What concerns me more is the amount of time between the TCMP
cycles. If there is, say, 4 years between samples of a particular type
of return, then the tax policy and administrative analyses and
audit selection models have to rely on data that is up to 7 years
old, given that unavoidable 3-year lag.

Before I make comments about burden, let me note that many
returns selected through the sampling process end up with taxes
owed, even though there was no indication ahead of time that there
would be noncompliance. The TCMP audits are better at discover-
ing unreported income than what would appear by just looking at
the returns. Also many taxpayers end up with refunds that they
did not expect to be getting because they had overcomplied.

Audits undertaken, for whatever reason, are burdensome and
anxious experiences which taxpayers would like to avoid. Is the
burden, in principle, excessive or unreasonable? Here I think my
analyses of Oregon State audits is relevant. Most of the audits I
studied were general audits that were not unlike TCMP audits by
the IRS. The taxpayers in Oregon considered them to be burden-
some, yes, but the vast majority we interviewed did not consider
them unreasonably burdensome, and by and large the taxpayers
came out of the audits feeling satisfied with the process and satis-
fied with the outcomes. If we focus on the fairness of the proce-
dures and the quality of the audits, many of the concerns about
burden, I think, will be met.

As has been anecdotally noted, many auditors, at least in the
past, resent doing TCMP audits. The normal criteria for evaluating
performance and allocating work in the examinations reinforces the
feeling that TCMP audits are an unreasonable burden on both
auditors and taxpayers.

In improving TCMP, attention needs to be placed on assuring
that auditors are positively motivated to produce quality audits
and quality data. They are the linchpin of the program and they
have to be committed team members. The Service, I think, is for
the next round taking solid steps in this direction.

Some suggestions Shave been made by others, including a Na-
tional Academy of Sciences Panel, as to how to improve the TCMP.
First, I think there should be an increasing of the capability for
analyzing TCMP data within the Service, probably through the
DORA sites. Second, we need to develop a team of TCMP audit spe-
cialists which may overcome some of the problems of the alienation
of the auditors from the process.

Third, we should seriously consider conducting annual TCMP au-
dits with smaller samples. Doing so would allow new patterns of
compliance to be identified and analyzed sooner and the data would
be available on a more timely basis. You could still group the an-
nual audit data into 3- and 4-year groups for the more detailed
kinds of analyses.


113

Testimony

To
‘Committee on Ways and Means
U.S. House of Representatives
‘Subcommittee on Oversight

By
Frederick (Fritz) J. Scheuren
Visiting Professor of Statistics
The George Washington University

Tuesday, July 18, 1995

My statement today on the Taxpayer Compliance Measurement Program (TCMP)
will cover —
© How TCMP data differ from data produced in the Statistics of Income (SOD)
program,
© The value and use of TCMP data, and
The benefits and shortcomings of the current TCMP design.
In addition, I would like to discuss some alternatives to the current approach that the IRS is
intending to take.

First, a disclaimer may be in order, I am here solely as a private citizen. However, at
present I am a part-time consultant to the Treasury Task Force on Tax Refund Fraud; also,
J have travelled to Russia for the Treasury Department to consult on tax matters. Indeed, Tl
be going to Moscow again next week; this is partly under Treasury auspices and partly for
‘The George Washington University, where I am employed full-time as a visiting professor
of statistics

Second, my overall perspective may be worth noting. Over the years my
involvement with TCMP has been both professional und personal. In fact, I worked as an
apprentice statistician to help draw the first TCMP samples back in the 1960's -- just after I
came to Washington to “serve my country” as an IRS employee. My recent knowledge of
TCMP is nothing like as detailed now as it was then. I will, therefore, speak quite generally,
posing questions more than offering answers. Much of what I have to say is very supportive
of what TCMP is all about. On the other hand, I have some questions on the approach
being taken. In my view, there are places where a wiser course may be open to the IRS.
‘ICMP and SOI Data

‘Let me begin now with a discussion contrasting TCMP and SOT data -- the kind of
data each program collecs, with what frequency and fous

Large-scale, usually annual studies are mounted of tax returns and information

documents as part of the Statistics of Income (SOI) program. This is the program,

incidentally, which I led for many years when I was at the IRS, These SOI data are
taken from the unaudited reports of taxpayers and third party filers.
© Taxpayer Compliance Measurement Program (TCMP) data, in contrast, have
historically been periodic in nature, rather than annual, Furthermore, the data
collected have been audited.
In no real sense are TCMP and SO! data substitutes for one another. Both are needed. For
‘some 80 years, SOI data have been made available to study who pays the taxes, to
benchmark measures of the National economy (like GDP), and to study the effect on
reported taxpayer behavior of changes in tax laws. TCMP data, available periodically over
the last 30 years, obviously have always had a compliance focus.

‘The main uses of TCMP in connection with SOI have been to provide correction
factors for the underreporting of SOI income amounts and the overreporting of SOI
deductions. What has not happened is to develop a unified design embracing both of these
important IRS statistical programs. The usually much larger (and considerably less
expensive) SOI samples could improve TCMP estimates — perhaps greatly. I will retumn to
this point later.

‘There are many others whom you will or have heard from on the value and uses of


122

These unwarranted inconsistencies impose a hidden and vast
burden on millions of taxpayers each year. This burden is
unnecessary. With the proper design of TCMP research and its
sincere application to problems not only of taxpayers but tax
administrators, a large step could be taken in reducing these
destructive enforcement deficiencies.

How could this be achieved? First, TCMP surveys should not
stop with the initial finding of the auditor. While these can
continue to provide valuable information, TCMP noncompliance
estimates should include the revisions that occur in tax
assessments after taxpayer appeals.

Studies have found, however, that taxpayers frequently do not
contest auditor claims they disagree with because such appeals are
costly and painful.? This fact means that more is required to
obtain a comprehensive picture of wrongful auditor claims. TCMP
should be used directly to assess the consistency of auditor
judgments. In pretesting the TCMP survey auditor judgments on the
same hypothetical taxpayer situation should be compared to
identify and correct inconsistency problems. Further, during the
TCMP audits themselves, the consistency of auditor judgments

should be continually monitored. This approach has been
successfully used by the Dutch tax authorities. (See footnote 8
above.)

This would not only provide a truer picture of tax
compliance, but help pinpoint those areas where IRS training and
supervision needs to be improved so that taxpayers do not face
unfounded auditor claims as often occurs during routine tax
examinations. While it is impossible to estimate the proportion of
taxpayers who confront wrongful government claims, there is fairly
persuasive evidence that they represent a lot of people.

CONCLUSION

In conclusion, TCMP is an extraordinarily valuable resource
that needs to be continued. Second, while TCMP is admittedly a
burden on the few, its product is an essential tool for reducing
the considerable burdens on all of the nation's taxpayers. Third,
although TCMP is valuable now, it can be improved. A key to such
improvement, in my.view, is to provide much wider access to TCMP
data so that a much larger community can contribute to the
essential task of identifying and correcting the shortcomings in
our tax system.

Sociolegal Research (1989).

9 General Accounting Office, ivi
, GGD-76-54, 1976); L. Hart
Wright, Needed Changes in IRS Conflict Resolution Procedures,
American Bar Foundation (1970); Susan B. Long, Measuring Tax
» Washington, D.c.: U.S.
Government Printing Office (1980).


127

Further, we find that these DIF audits generate significantly larger assessments on average than
are generated by the remaining non-DIF audits. Our findings strongly suggest that DIF, and
hence TCMP, is indeed a critical factor in audit selection.

‘Second, TCMP is also useful in helping IRS researchers discover pattems of noncompliance
that have been overlooked by existing audit programs. A good example of this is the discovery a
few years ago, based on an analysis of TCMP data, that households were claiming millions of
fictitious dependents. The elimination of this tax scam has saved the federal government billions
of dollars.

I will now discuss what I consider to be the three main alternatives to TCMP. One.
alternative is to rely on ordinary IRS audit data instead of TCMP data in the development of audit
selection guidelines. In fact ordinary audit data is not an adequate substitute for TCMP data.
‘TCMP is a random sample and therefore provides an accurate picture of the entire taxpayer
population. In contrast, ordinary audit data includes information only about households whose
returns looked sufficiently suspicious, according to existing audit selection criteria, to trigger an
audit. Households that discover a new way to evade taxes and elude existing selection criteria are
not represented in ordinary audit data. As a result, the analysis of ordinary audit data cannot
readily detect such new forms of evasion, whereas an analysis based on TCMP might

The discovery of the fictitious dependents scam is a good example of the difference between
‘TCMP and ordinary audit data and shows how important TCMP is for discovering new or
previously neglected forms of evasion. The problem of fictitious dependents was never apparent
in ordinary audit data, because existing audit selection criteria ignored this issue, and, because of
this, few of the households selected for an ordinary audit were found to have claimed an excessive
number of dependents, The problem only became apparent after a careful analysis of TCMP data,
which revealed that a significant fraction of households were claiming too many dependents. Of
course, once the problem of fictitious dependents was dicovered, audit selection guidelines were
modified to address the problem. Let me summarize my view of the uses of ordinary audit data.
Ordinary audit data is good for evaluating existing audit programs, as Brian Erard and I have
done. It is not well-suited, however, to the development of new audit selection criteria, because it
does not keep the IRS abreast of changing evasion patterns.

A second alternative to TCMP is survey data, Unfortunately, survey data is extremely
unreliable. Typically, 70% or more of respondents on surveys claim that they pay their full tax
obligation, even though the hard facts from TCMP show that in most years more than half of all
households underpay their taxes to some degree.

Finally, a third alternative is to abandon statistical analyses based on TCMP and instead rely
solely on examiner expert judgments in the development of audit selection guidelines. While such
expert judgments are currently used effectively in combination with DIF, they are unlikely to be a
‘good substitute for DIF. Further, even if expert systems are used more in the future than they are
at present, TCMP is likely to provide a good training ground for experts, exposing them to the
full range of cheating strategies.

Supposing that TCMP is essential for IRS audit programs, a question still remains as to how
big TCMP should be. I will conclude my testimony by briefly addressing this issue, confining my
remarks to the household component of TCMP, which I know best. Previous TCMPs sampled
approximately 50,000 households, whereas the proposed TCMP would sample 90,000
households. In my experience the previous TCMPs are thin in their coverage of certain taxpayer
‘groups and locales, so I do not think it would be wise to shrink the sample below 50,000.
Enlarging the sample would allow the IRS to increase its sample size for some of these groups,
which might lead to a substantial payoff in the long run. However, these benefits are uncertain
and might turn out to be relatively modest. I am not familiar with all of the arguments being made
in support of enlarging the TCMP. Based on what I do know, however, I am not convinced that
the benefits to be earned from expanding the program are worth the substantial cost involved.

In conclusion, based on my extensive study of tax compliance and tax enforcement programs,
I believe that TCMP is important and productive and should continue. I am not convinced,
however, that it needs to be expanded.

I thank you for the invitation to testify. I hope my testimony is useful to you.



151

taxpayers." GAO/AIMD-94-120, June 15, 1994,
page 38.

The question this Subcommittee should be asking is not whether the
IRS should be allowed to conduct TCMP audits of honest citizens.
This Subcommittee should be asking why it is the IRS, the
government's tax collector, cannot comply with even the most basic
recordkeeping and data reporting requirements it expects of every
citizen.

All the data in the world is of absolutely no value to an agency
which cannot record, assimilate or use it correctly.

3. TCMP Burden on Taxpayers.

The government bears a direct responsibility to administer the laws
in a fashion which creates the least amount of burden for its
citizens. Each year, it seems Congress heaps more information
reporting requirements, new tax forms and more recordkeeping
requirements on the average citizen in order to comply with tax
laws. As the law becomes more cumbersome and complex the cost of
compliance for all, including the IRS, goes up. TCMP unreasonably
adds to the cost of compliance for many citizens.

TOMP selections are made on a completely random basis. Those
selected are not chosen on the basis of any objective criteria.
They are not suspected of making any errors. They are not suspected
of cheating. Yet they are forced to undergo the most grueling kind
of audit.

They must endure endless hours of preparation, copying records and
reconstructing their financial activities. They must take time from
work and family at their own expense to comply with an endless list
of requests and questions served upon them by the examiner, only to
face a new list when that one is satisfied. In many cases they must
hire a tax professional to represent them. Fees for services run
from $100 to $300 per hour. A professional's time in connection
with a TCMP audit can run to 40 hours or more, depending upon the
complexity of the case.

Many citizens have described the TCMP audit as a kind of rape. The
agent makes repeated, sometimes unreasonable demands for
information, rummages through every aspect of a person's life,
drags the ordeal on month after month, and creates substantial
expenses in the process. At the same time, the individual agent is
not likely to understand the law he is enforcing. After all is said
and done, his results are likely to be wrong.

We must ask the question, what is the point?

TCMP audits often delve into areas which are not necessarily shown
on the tax return. For example, citizens are called upon to prove
the income declared in the return is correct, but must do so with
evidence which goes beyond bank statements and W-2 forms. To do
this, the IRS often uses Form 4822, Statement of Annual Personal
Estimated Living Expenses. Since one’s personal living expenses are
not an item in the tax return, most citizens keep no records of
such expenses, including things like clothing, food, hair cuts,
gifts, etc. Yet Form 4822 ask a citizen to reconstruct and report
all such expenses.

If one is undergoing an audit of, say, tax year 1993, during the
year 1996, he is asked to "remember" what he spent on hair cuts and
the like in order to provide an “accurate” picture of his spending
habits to the agent. From this “accurate” information, the agent
then ascertains whether the citizen's claimed income was sufficient


CONTENTS

Advisory of July 10, 1995, announcing the hearing

WITNESSES

Internal Revenue Service, Phil Brand, Chief Compliance Officer .... 2
U.S. General Accounting Office, Jennie S. Stathis, Director, Tax Policy and
Administration Issues, General Accounting Division

American Bar Foundation, Chicago, Ill, Kent W. Smith ....
Feinstein, Jonathan S., Yale School of Management, New Hi
Gibbs, Lawrence B., Miller & Chevalier ..
Goldberg, Fred T., Jr., Skadden, Arps, Slate,
Long, Susan B., Syracuse University, Syracuse,

National Association of Enrolled Agents, Joseph F.
National Taxpayers Union Foundation, David L. Keating
Scheuren, Frederick (Fritz), George Washington University,
Smith, Verenda, Alexandria, Va ..
Sparrow, Malcoim K., Harvard University, Cambridge, Mass

SUBMISSIONS FOR THE RECORD
US. Department of the Treasury, Eric J. Toder, Deputy Assistant Secretary,

statement ..
Joint Committee on Taxation,

ennet}

American Institute of Certified Public Accountants, Deborah Walker, letter
Pilla, Daniel J., St. Paul, Minn., statement .....

amy

139
141

143
145


145

STATEMENT OF DANIEL J. PILLA
‘ST. PAUL, MINN.

Madam Chairman and Members of the Subcommittee:

My name is Daniel J. Pilla. I ama tax litigation consultant from
St. Paul, Minnesota. For nearly 20 years, I have been actively
engaged in the defense of taxpayers’ rights. My work focuses in the
areas of IRS abuse prevention and cure, taxpayers’ rights issues,
and problems resolution. Over the years, I have been involved,
directly or indirectly, with thousands of cases. I have seen every
kind of tax case imaginable, and some that are not imaginable.

I am the author of eight (8) IRS self-help defense books. In
addition, I am the editor of two nationally circulated newsletters.
one is addressed to the general public. The other to tax
professionals. In connection with my work as an author, I have
appeared as a guest on more than 3,000 radio and TV talk shows, and
currently conduct more than 500 interviews per year. In that
capacity, coupled with my consulting work, I talk to about one
hundred people per week who face difficulty with the IRS.

At present, I am the executive director of an organization known as
the Tax Freedom Institute (TFI). TFI is a national association of
tax professionals, including attorneys, accountants and enrolled
agents who have dedicated a portion of their practice to defending
taxpayers rights against abusive IRS practices. As the executive
director of TFI, I am responsible for developing continuing
professional education materials to train these tax pros in matters
of tax law and procedure. I have taught courses in tax law and
procedure having to do with taxpayers rights for numerous
professional associations, including the prestigious Penn State Tax
Institute.

This statement is submitted on behalf of myself in my individual
capacity, on behalf of the Tax Freedom Institute, and on behalf of
every American business and individual taxpayer.

One question before this subcommittee is whether the IRS’ Taxpayer
Compliance Measurement Program (TCMP) provides sufficient research
value to the IRS and Congress in the areas of tax administration,
taxpayer compliance with the tax laws, and policy analysis as to
warrant continuation of the program. Another question is whether
the program is overly burdensome to taxpayers selected for such
audits.

For reasons I shall elaborate upon in detail, I submit the program
should be discontinued. First, the program does not provide
adequate, accurate or reliable data to either the IRS or Congress
in any of the areas of concern. Second, even if the IRS were able
to gather accurate data, history has shown the agency is unable to
assimilate or utilize the data it has. And third, the program is so
invasive and subject to abuse, taxpayers cannot be adequately
compensated for being forced to participate in such a program.

1, The results of TCMP Audits are Unreliable.

The TCMP audit is a grueling line by line examination of the tax
return selected. Taxpayers are called upon to prove their names,
social security numbers, the names and births of their dependent
children, and so on throughout the entire return.

The results of the audits are complied into a sophisticated data
base which has many uses, Results are used to determine patterns of
non-compliance, to evaluate the IRS’ policy and enforcement needs,
and to assist Congress in the areas of legislative policy. Another
primary use of TCMP data is to formulate the data base used in the
Discriminate Function System (DIF).


106

Mr. PorTMAN. I like your candid approach to this. I would agree
with you on the market segment data, not just because Procter &
Gamble is in my district, but because, in fact, as I tried to articu-
late earlier, I think there is a lot of new technology and new tech-
niques to get at some of the same information the IRS is rightfully
looking for in this latest program.

So I would hope, too, that perhaps we could utilize some of that
private sector data that is already out there.

Let me ask you another question in your role as representing the
enrolled agents. Perhaps it is something that the IRS officially
must address, but do you understand how the burden of proof is
going to work? Let us say that someone, like Ms. Smith, makes a
claim about her lifestyle in connection with the economic reality
approach. It cannot be sustained. Either you have lost your mar-
riage license or you know you do not have a title for the ridin;
lawnmower that you bought 2 years ago, or you got from a frien
or traded with your neighbor, or whatever it is.

How does the burden of proof change, if at all, as compared to
a normal audit? Do you understand how that is going to work?

Mr. LaNE. Yes, I do. There is no change in the burden of proof
in this instance because it is a civil examination and the burden
of proof is with the taxpayer not with the Service.

Mr. PoRTMAN. OK. So she has to prove that she did not do some-
thing, even if she does not have the information on hand. That sort
of is a transition to the appeals process and you talked a little in
your testimony, I think, about the fact that 97 percent of the cases
that go to appeal are resolved. What happens to those? Are the ad-
justments made pursuant to the IRS or their estimate? When you
say they are resolved, what is the typical outcome, do you know?

Mer. ATING. Well, according to George Guttman’s article in Tax
Notes, the overall sustention rate for issues that go to appeals or
litigation is more than 50 cents on the dollar. The taxpayers and
the IRS are able to reach agreement in 97 percent of the cases that.
go to an appeals officer.

I think that is probably because No. 1, the level of standards and
professionalism at the appeals process is probably higher than at
the auditing process. No. 2, there is probably also Setter knowledge
of the tax law and better understanding of the hazards of litigation,
both for the IRS and the taxpayer at the appeals level.

But, certainly, from GAO reports and from what I have heard
from our members who are tax professionals is that at the auditing
level there is often a lack of knowledge about the proper amount
due. There are positions taken. It is almost like a negotiation strat-
cay rather than trying to figure out what is actually——

ir. PORTMAN. Starting out high and ending up lower?

Mr. KeatTInc. Right, exactly. Now, I hope in the training for the
TCMP that the auditors will not be dealing with these types of au-
dits in the same way. They have to take a view that if the IRS is
going to have accurate data, the TCMP audit is not something that
is a negotiating technique with the taxpayer to find the highest
amount that they think they can squeeze out of the taxpayer, but
something that is the actual correct amount due.

Mr. Portman. The inference I draw from what you said earlier
about the 97 percent is that a great many of those cases are re-


66

While much of this "learning" seems like common sense
various TCMP studies have provided useful order-of -magni-
tude measures and may have told us something about trends
over time.

Nevertheless, there seems to be little real
benefit to be gained from a new study of the tax gap
based on the 1994 TCMP. In particular:

* From a qualitative standpoint, we are likely to
learn nothing new about the overall tax gap and
its major components.

* From a quantitative standpoint, the tax gap
estimates are very crude measures. In absolute
dollars, they are probably too high -- or too
low -- by many tens of billions of dollars
Given the limitations on other researchers:
development and use of indivi’ial taxpayer-
level data, we probably will never know how far
off the mark these estimates are, and never
even know the direction of the error

* From a quantitative standpoint, the 1994 TCMP
will provide little reliable data regarding
changes in voluntary compliance levels, much
less the magnitude of any such changes.‘

* From a quantitative standpoint, it is not clear
that estimates derived from the 1994 TCMP will
be materially different, or more accurate, than
projections made from other data sources.

It has been suggested that the 1994 TCMP will
provide far more accurate tax gap estimates, and will
provide a useful baseline for determining whether the IRS
achieves its stated goal of increasing voluntary compli-
ance levels from "about 84%" to over 90% by the year
2000.7 This rationale is not persuasive for several
reasons: (1) it suggests far higher reliability in the
estimates than is warranted; (2) there are other, far
less costly and intrusive ways to develop estimates of at
least equal reliability; and (3) the resources in ques-
tion could be better used to help achieve the stated
objective

In this context, we also question the underly-
ing justification for ongoing estimates of the overall
tax gap. What will happen differently if, based on the
1994 TCMP, the IRS estimates a tax gap of $75 billion

There are may reasons to question whether the 1994
TCMP will permit a reliable analysis of compliance
trends. For example, the IRS has made substantial
changes in audit techniques, training programs, and
the information provided to its auditors. It has
also made substantial changes in its data collection
and retrieval systems. See generally, GAO/GGD-95~-
39. Margins of error are quite large (particularly
where unreported income is at issue), and there is
no reason to believe the bias is the same for all
TCMP studies.

. GAO/GGD-93-52, at 12.


52
Responses to Questions from the Subcommittee on Oversight
A. MEASUREMENT OF TAXPAYER BURDEN

Background: There is no historical measure of taxpayer burden addressing the
taxpayer's time, number of contacts and appointments, and out-of-pocket costs incurred
in the course of compliance with a TCMP examination. The following information is
estimated based upon Auditing Standards and Process Measures data compiled
beginning April 1995. The Process Measures data have been accumulated from
general program examinations in three of the seven IRS regions and capture the time
and the number of contacts with the taxpayer and/or representative in the following four
stages of the examination: Pre-audit Analysis, Inspection of Books and Records, issue
Resolution, and Closing. Contact with the taxpayer and/or representative takes place
during Inspection of the Books and Records, and Issue Resolution stages. The time
estimates are reflective of the actual hours the revenue agents and tax auditors
allocated to the case in those stages when taxpayer contact takes place and assumes
that taxpayers were active participants during these stages.

The number of times a taxpayer will need to meet with an examiner and the total
time spent by the taxpayer in any examination (including TCMP) is dependent on many
factors, such as the complexity of the retum and the condition and availability of the
taxpayer's books and records.

Question 1: An estimate of the average amount of time taxpayers must spend in
meetings with IRS personnel when responding to a TCMP audit.

Answer: The process analysis data from the general program cases can be projected
to TCMP cases using historical TCMP rates of increase in examination time as follows:

General TCMP Increase TCMP
Program Rate Examination
Revenue Agents 30 53% 46
Tax Auditors: z 88% 13

It is important to note that, for business audits, it is not customary for the
taxpayer to be present for the entire process of the examiner's inspection of the books
and records. Therefore, we would expect taxpayers or their representatives to
participate in less than the 46 hours of examiner activities indicated above


101

‘The Administration and the IRS have failed to identify legislative initiatives to
improve EITC compliance, and the Administration pushed through legislative changes in
1993 to make the program more generous.

IRS spokesman, Steve Pyrek, has stated that the TCMP is “... only done
sporadically because it's very expensive and time-consuming .... People are doing things
now and living in ways they weren't five years ago .... As economic life changes we need
to keep up with those changes and with what's going on in society.”

Mr. Pyrek has a point. But based on experience, we doubt that the TCMP will
accomplish what he describes as the IRS goals and objectives for the TCMP.

First, the economic and lifestyle changes that Mr. Pyrek describes — particularly
with regard to monetary matters — are accelerating as electronic information technology
plays a more important role in our economic system.

This Committee's own Press Release announcing this Hearing highlights the fact
that Congress has not yet received reports on the findings of overall compliance from the
1985 and 1988 TCMP surveys. Clearly, delays of any measurable time period in obtaining
whatever results derive from the proposed 1994 TCMP audits would render those results,
al best, of diminished usefulness and, perhaps ... meaningless. This is further magnified
by the obvious overwhelming public support and Congressional interest in a very
significant revision of our national tax structure. To arbitrarily subject 153,000 taxpayers
Or entities to the costs and burdens of this program seems on the whole, misplaced.

Second, the use of 280 million dollars of IRS resources to derive detailed
information from a population of Americans that do — in fact -— file income tax returns
when much of that information is available by other means appears to be a colossal misuse
of taxpayer dollars.

Third, before undertaking another TCMP, the IRS should be required to study
other, less intrusive, alternatives that will provide more timely information. There remains
the unanswered question whether yet another TCMP is underway because of a bureaucratic
‘mindset that says — “that’s the way we've always done things.” For example, the IRS
should consider looking at fewer items on more returns, rather than every single item on
every return selected for 2 TCMP audit. By looking at fewer items on more returns, this
would at least spread out the burden somewhat so that the TCMP compliance burden is
allocated somewhat more fairly.

Also, some members of the practitioner community believe that the IRS sees the
‘TCMP program and its attendant publicity as a form of deterrent. We do not believe that to
be the case

Conclusion.

‘The TCMP program. as it presently exists, is overly burdensome on taxpayers and
arbitrary in the selection process. Much of the information the program attempts to gamer
‘can be secured by alternative means. Moreover, by the time meaningful results can be
derived from the program, the information witl almost surely be rendered obsolete or
irrelevant by today’s rapidly changing information society or passage of comprehensive tax
reform, We hope that the IRS uses its resources on projects more likely to improve
taxpayer service


26

APPENDIX II APPENDIX II

Population Sample size
of market: Percent:
segment All that are
Market segment (000) 1040s _| returns | 10408
Finance and insurance 246| 1,758| 4,040 43.5
Air, bus, and taxi 75|_1,508| 2,805 53.8
Other transportation 381 1,522 3,703 41.1
and utilities
Amusement , : 194| 1,507{ 3,671 41.1
recreation, and
motion picture:
Medical and health 444] 2,042] 5,034 40.6
Business and personal 509} 1,682] 6,144 27.4
services
Hotel, lodging, 13| 1,509| 5,473 27.6
automotive
Unable to classify 57 | 12,024 15,317 78.5
Miscellaneous s32| 2,382| 2,382 100.0
business and personal
services
Miscellaneous 465| 3,159| 5,496 57.5
services
Totalt 118,071] 92,185 | 152,534 60.4

‘Totals may not add due to rounding.

Source: Final 1994 TCMP Sample Design.


22

In concluding my testimony, I would like to again take this
opportunity to indicate our support for TCMP. IRS’ 1994 TCMP
plans, if effectively implemented, should go a long way towards
improving its collection of compliance data. Better data provide
the foundation for better compliance programs as well as the
capability to avoid auditing compliant taxpayers. While the
start of audits will be delayed at least 1 month, it appears that
TCMP audits can still be completed on time. This can only be
done, however, if IRS makes a concerted effort to finish
development and testing of its data collection system, as well as
ensure that all auditors are adequately equipped and trained by
the end of 1995.

This concludes my testimony. We will be pleased to answer any
questions you may have.


105

Mr. KEATING. Well, I suppose it depends on what we ultimately
come up with as a part of tax reform. But certainly it is quite pos-
sible, especially on the definition of income including how much in-
come is reported and whether it is accurately reported, that the
TCMP can provide information that is applicable for current or fu-
ture tax administration.

Mr. Hancock. How would you recommend that this information
be gathered on the current behavior pattern of taxpayers relevant
to the existing law?

Mr. KEATING. I do not know enough about the statistical develop-
ment of TCMP to say for sure, but I am sure of one thing. When
you prepare your tax return or when someone is auditing the tax
return, the law as it exists now is so complicated that there is a
huge potential variation in what an expert would say is the proper
amount of tax that is actually due.

You referred, earlier in the hearing, to the Money Magazine re-
port, where they had 50 professionals look at the same theoretical
tax return and they came up with 50 different answers. Those are
the kinds of problems we are facing with the Tax Code today—an
incredibly complex tax law that is difficult not only for the tax-
payer to comply with but the Service to administer.

‘hose are problems that I would imagine the TCMP process has
a great deal of difficulty with as well.

ir. HANCOCK. Well, you spoke about the IRS having access to
all kinds of information, data bases, Mr. Lane mentioned it, Dun
and Bradstreet reports, and all that type of taxpayer information.

Do you support the idea of IRS using these external data bases,
as Mr. Lane suggested? Would you support that?

Mr. KEATING. I doubt it. I think it is probably a nonissue anyway
because the firms that compile these data bases, much of them are
direct marketing oriented firms and they are not going to want this
data being used for tax administration. If they do allow IRS access
to the data, the people that compile it probably think that a lot of
the data that they are able to get now on a voluntary basis from
people will not be forthcoming, because they think it might be used
for tax administration or auditing.

So I do not think the direct marketing community or industry
would ever allow this data to be sold to the IRS. In fact, in pre-
vious times when the IRS tried to obtain samples of demographic
data from the industry, I recall a great deal of resistance to this.

I think the industry will continue to resist and do so successfully.

Mr. HaNcock. Thank you.

Mr. Portman.

Mr. PorTMAN. Thank you, Mr. Chairman.

First of all I want to apologize for not being here through your
testimony. As our chairman has probably explained, our schedule
is crazy these days. We have a lot of conflicting scheduling items,
and I just apologize to those who are here today that we all cannot
be here more.

I have read through the testimony. I have not read every word
of it, but I have skimmed all the testimony that I received and I
appreciated all of your views. Mr. Lane, it is good to have you back
before the subcommittee again.

Mr. LANE. Thank you.


34

Chairman JOHNSON. But is there not a difference in the ability
of the different systems to collect information?

Mr. BRAND. No. Both systems will gather the same amount of
data collected from the TCMP. It is the ease with which you com-
plete the examination and the ease with which you issue the reve-
nue agent’s report, that is the difference between the two systems.
4 Chairman JOHNSON. Are you satisfied that they will be able to

lo this?

Ms. STATHIS. We are very hopeful that it is going to work.

Chairman JOHNSON. You mentioned, Ms. Stathis, in your com-
ments that the criticism of the surveys has been, in part, that they
have not identified the underlying reasons for taxpayer errors. Do
you think that this new TCMP effort will do a better job of identify-
ing the reasons for taxpayer noncompliance?

Mts. Sratuis. It should. In the past, infermation on the reasons
for noncompliance was not routinely coliected in any kind of
checksheet fashion. Often the auditor would put a reason in the
workpapers but those were not computerized, so you had to do a
lot of research and work to find the reasons. This year the auditors
are going to be asked to enter codes into the system to record what
they think the reason is and to identify the tax issue. The informa-
tion should be very helpful to Congress as it considers what
changes should be made to the Tax Code. You will be able to know
which particular issues are giving taxpayers the most problems.

Chairman JOHNSON. Do you think that the degree to which they
are pursuing the issue of the status of various employees is ade-
quately addressed in their plans?

Ms. Status. IRS is foing to be doing some followup work on em-
ployment issues and if it is carried out as currently planned, more
information on employment issues will be available than was ever
available before.

Chairman JOHNSON. One last question and then I will yield to
my colleagues.

One of the things that concerns me about the amount of re-
sources that we are putting into this effort is that it is very big
money, and probably the biggest problem in the Tax Code is the
underground economy. This seems to be totally irrelevant to the
people who do not pay their taxes.

Now, is there any aspect of this program that tries to reach to
that problem of the underground economy?

Mr. BRAND. This TCMP program is focusing primarily on the fact
that the largest portion of the estimated tax gap is unreported in-
come. Now, we have only estimated the legal sector income. We
have tried various different times in the past to estimate the tax
gap from the illegal sector. We have never been successful in com-
ing up with a figure as far as legal sector income is concerned.

would just say, however, that we do estimate that in the legal
sector, as far as unreported income, that you are talking approxi-
mately $62 or $62.5 billion.

Chairman JOHNSON. That has been discovered in past report
studies?

Mr. BRAND. In the past, we used two—I am sorry, Madam Chair-
man, I may have cut you off. We used two processes to basically
estimate the tax gap. It is based on the TCMP but the TCMP data


115

sizes. Work which I initiated some years ago on a TCMP sample of Form 990-T filers
showed some of this promise from improved estimation methods. This too would be
something to study, if a pilot were conducted.

‘Study Analysis. -- At one point the upcoming 1994 TCMP was supposed to be the last
traditional TCMP. New measures based on operational data were to replace the program
Frankly I have not followed this particular possibilty, since it was discussed some years
ago. If this is still seriously being considered, it raises many concerns. What is needed is not
a TCMP effort divorced from these operational measures but a blend of the two over
several years. Under such a proposed scenario, it is conceivable that TCMP could be
reduced in scope as the newer methods are seen to be working. It is unlikely, though, that
‘TCMP should end altogether, even then.

Summary and Possible Alternatives

Let me summarize my comments about TCMP briefly and then look at some

possible alternatives. So far I have made two main points

© First, TCMP is an irreplaceable technique for understanding a whole host of
‘economic and tax compliance issues.

© Second, Ihave raised a number of specific questions about the 1994 TCMP that
may be worth further study. My main point throughout is that the current 1994
plans be scaled down to be simply a "dress rehearsal."

Implicit in my discussion has been the idea that everything be done to reduce the burden on

individual taxpayers of TCMP. This should be a major consideration in framing alternatives.
‘What about possible alternatives, then? A key question not addressed by me is what

should happen after the 1994 “rehearsal” that I have recommended. Basically, I would

suggest —-

@ ~~ TCMP become a continuous program,

© "Much smaller annually than the 1994 sample,

© Carried out by a permanent cadre of employees,

© With an adaptive statistical design that could be responsive to new conditions and to
what was being learned from previous studies.

To give TCMP some completely new thinking, the IRS should seek help from the National

Academy of Sciences -- a practice it has followed with scme success in the past. One issue

for the National Academy to iook at would be how to integrate the SOI and TCMP designs

0 each can be strengthened; also the Academy might be asked to consider how to integrate

special compliance studies into a general framework, like that provided by TCMP.

Allow me two last comments and then I will be happy to answer any questions that

the Committee may have:

© First, Ihave tried to express some very technical ideas in non-technical language
My apologies for what I fear are the many points at which I may have failed

© Second, I hesitate to use this analogy but it may fit. Alvin and Heidi Toffler have
been talking about building third wave systems to replace second wave ones, My
criticisms of the current TCMP plans are consistent with the Tofflers' ideas. What I
am recommending is a third wave approach to TCMP. At present, the IRS has taken
largely a second wave one.

1 am done now. My thanks to the Subcommittee for inviting me to participate. Also, I wish

my former colleagues at the IRS the very best in their work on TCMP. However much we

may differ on approach, the work IRS is trying to do is important and valuable; I have no

doubt it will be carried out with professionalism throughout.


136

ers within Examination. Given the specialized nature of TCMP audits and their dual purposes
of enforcement and research, there perhaps should also be TCMP specialists. These special-
ists could be affiliated with the DORA sites while still funcitoning within Examination, and
they could serve as liaisons and research resources within Examination at the district or post-
of-duty level Correspondingly, the criteria for evaluating their performance and for advance-
ment would have to be broader and somewhat different from the criteria for normal Examina-
tion staff. In the funding for these specialists, there probably should also be some recognition
of their dual affiliation and multiple roles so that Examination would not, quite reasonably,
feel it was paying out of its budget for services to other areas of the IRS and to other govern-
ment offices. Without some such organizational change, there are going to be continuing
‘structural and incentive pressures toward alienated, hired-hand work on TCMP audits.

Smaller Annual Samples. There are several arguments for moving from large samples drawn
every few years to smaller samples drawn every year. The work loads of the TCMP special-
ists I just suggested would be evened, and there would be other efficiencies in avoiding cycles
of starting up and closing down. Moreover, new patterns of noncompliance could be identi-
fied and analyzed sooner, and the data would be svailable on a more timely basis. For some
broad stoke analyses and early warning systems, the annual data could be used. For audit
selection models and most other detailed analyses, the annual data could be grouped into 3- or
4-year moving clusters. One difficulty with this design is that the data from some years would
have to be adjusted for tax law changes before the analyses were performed, and there would
inevitably be some additional estimation involved. However, under current procedures, the
audit selection models are having to be adjusted after the fact for tax law changes, also with
estimations, but with no data on how taxpayers are actually responding to the changes. With
annual samples we would at least have some early evidence on these response changes.

TCMP and Basic Tax Reform

Finally, questions have been raised about how TCMP relates to some of the fundamental
changes in our federal tax system that are currently be developed and debated. Regardless of
the tax system, there will always be a need to monitor compliance, to analyze the factors af-
fecting it, and to evaluate administrative and legislative changes in light of the compliance
data. As many of us have argued, measuring and analyzing compliance effectively and accu-
rately will require some sort of probability sampling that is independent of the expected level
of compliance and general audits covering the relevant aspects of taxpayers’ financial situa-
tion: In short, there will always be sound administrative and legislative need for something
like TCMP.

Many of the tax reforms being suggested still involve the reporting of income. Currentl
most noncompliance, both in terms of the number of taxpayers and the number of dollars, is
on the income side, not on the subtraction side. ‘These compliance problems will not com-
pletely disappear by eliminating the subtractions and simplifying the returns. Analyses of the
current TCMP data about under reporting various types of income and the factors affecting it
could be used to evaluate the compliance implications of the alternative reforms.

Those reforms focusing on consumption, especially those involving a VAT or other sales
and transaction taxes, will rely upon the accurate reporting and collection of taxes by some
sectors of the economy that are now among the least compliant (again, in many cases uninten-
tionally s0) and with some of the worst record keeping relative to business needs. Careful
analyses with TCMP and other data about possible compliance problems with the reporting
and collection of consumption and transaction taxes should be done before the federal gov-
ernment decides to rely primarily on such sources of revenue.

In summary, regardless of the shape of future tax reform, the concern with TCMP now
and for the foreseeable future should be on how to improve the program and how to utilize its
data more fully in planning and evaluating legislative and administrative reforms. The focus
should not be on abandoning the program or its essential characteristics.

This concludes my prepared statement. I would be pleased to respond to any questions.


58

Chairman JOHNSON. I would like you to respond to the criticism
of the TCMP that auditors are given little leeway to make the
kinds of judgments that IRS reviewers commonly make and that
tends to increase the number of adjustments made on appeal in the
taxpayer’s favor.

Mr. BRAND. The issue here is that we do require our examiners
to, in fact, look at the line items. Again, the depth of that verifica-
tion is the judgment that the auditor can exercise. As you under-
stand, we are trying to determine compliance on a line-by-line basis
so we can then use this to develop our discriminate function activi-
ties so we can select those tax returns that are most in need of
change in future situations. So I believe it is a valid statement.
Whether it is a criticism or not——

Chairman JOHNSON. I wish you would give some thought, Mr.
Brand and Ms. Stathis, to this issue. I can understand that for re-
search purposes you might want to draw a very hard line. But I
think in fairness to taxpayers, they at least be given the informa-
tion that under this program we do draw harder lines and the like-
lihood of success on appeal is very great, since the judgment that
IRS officers could normally exercise would probably read this dif-
ferently.

We have to do something to make sure that, in a sense, subjects
or victims of these audits are not unduly punished. For many, the
matter of going to appeal is a formidable challenge and many just
may be simply discouraged from doing that because it is formida-
ble. I think this issue of the different and harder standard that tax-
payers are held to under the TCMP is a matter of equity that we
need to think through, and we would like your recommendations
as to how to handle that.

Mr. BRAND. Just one quick response in terms of the standard.
The standard that is the same is that we do not assess de minimis
amounts. So even though there is an adjustment as a result of a
TCMP audit, it still would not result in additional tax. We would
record that information and it would help us select returns. But we
are not interested in assessing de minimis amounts. Again, we
maintain those assessment levels as confidential, but we would not
assess a small amount of tax, even though we would record it.

Chairman JOHNSON. Thank you very much. I thank the panel.

The next panel, we will use the lights both for those who are tes-
tifying and for the members. I always feel it is important that we
have as much time as we want to get the professional administra-
tors’ side of these issues.

[Recess.]

Chairman JOHNSON. The subcommittee will reconvene. I regret
that I do have another obligation at 12:15 that requires that I ex-
cuse myself, so I will not be able to hear all of the testimony, al-
though I intend to return. But I am very anxious to hear as much
as possible, and so I am going to start with Mr. Goldberg and move
to you, Mr. Gibbs, and Mr. Sparrow. If you will adhere as closely
as possible to the 5-minute rule, I would appreciate it.

Mr. Goldberg.


112

990-T) was one in which an efficient estimation procedure really
made some big payoffs.

I am concerned about the study analysis issues. But I think I
will pass over that right now. A lot of people have talked about.
those issues already and others that are sitting here with me may
as well.

So what am I proposing? For the immediate short run, first, one
thing that I have not said here but that is in my testimony—I
think the TCMP is irreplaceable and there must be a TCMP. I am
not saying anything to disagree with that.

On the other hand, I think a smaller, targeted, better planned,
more carefully developed TCMP, in terms of the dress rehearsa
idea, is essential for the fall.

What would I recommend that we do afterward? Again, I have
seen it in the testimony of others today. I would recommend that
TCMP become an annual study, that it be smaller annually. Cer-
tainly a lot smaller annually than it is for 1994. It could become
more efficient over time. One of the things that we need to learn
from the Japanese is “just-in-time” procedures and short cycle
times. If we do TCMP the right way, we can learn how to do it bet-
ter and better; reduce the burden on the taxpayer by makin
TCMP smaller and smaller; and the burden on the resources of I
would be a lot less as well.

That’s my recommendation. Since many of you here are in the
political world, you understand the nature of rolling samples, of
tracking polls. This is the way to do business—quite different than
doing a measurement every few years. I think this approach should
be taken in TCMP. Furthermore, I think it is consistent with the
Service’s desire to modernize itself.

Thank you.

[The prepared statement follows:]


76

believe that the TCMP instrument itself forms a vital and perhaps
indispensable or irreplaceable part of that monitoring apparatus.

The danger the TCMP helps IRS avoid is one that is common to
regulatory agencies and to intelligence agencies. Once you start fo-
cusing on a particular thing, your belief that that subject area, that
problem area is important can become a self-fulfilling prophecy. If
you are an intelligence agency and you believe that a particular in-
dividual is central in an organization, you then focus more surveil-
lance on that individual. As you do so, you learn more and more
about them, and the more you learn about them, the more they ap-
pear central in your thinking. It is a self-fulfilling and circular way
of doing business.

The danger in regulation or compliance agencies is similar, that
you can delude yourself into thinking that you know exactly what
these noncompliance problems are, and if you have an idea about
what they are, that is what you focus on. Those would be the au-
dits and the examinations that the IRS would conduct. It is quite
conceivable that over here on one side, far away from where your
sights happen to be trained, new patterns of noncompliance are
emerging of which you are completely oblivious.

Random audits are as unpopular within regulatory agencies as
they are outside. Auditors will always tell you that they prefer to
be allowed to focus and target their efforts, because they could
raise more revenue that way. They are right, they certainly would
raise more revenue that way.

But that is not the point. The whole purpose of random audits
is that it gives you important information which allows you to do
long-range planning and to adjust and redirect your resources over
the long term. That is exactly the purpose of the TCMP data. It
allows the IRS to adjust their audit selection formulas and target
examination and audit resources, and to select enforcement actions
that have the greatest impact.

Perhaps one way of looking at this is to remember that the IRS
does more than 1 million audits per year which are focused. The
critical question is whether those 1 million audits per year are well
focused. If they are going to be well focused, what instrumentation
and what data is that focusing based on? This is a relatively small
number of random audits which helps to ensure that the bulk of
the audits are in fact focused on the right people and the right pat-
terns of behavior.

Thank you.

[The prepared statement follows:]


28

APPENDIX II APPENDIX IT
Le larke’ ts, e 1
Market Sample size
segment Percent
population All that are
Market_segment (000) 11208__| returns | 11208
Finance and insurance 103 994] 4,040 24.6
Air, bus, and taxi 8 382| 2,805 13.6
Other transportation 76 963| 3,703 26.0
and utilities
Amusement , 46 963] 3,671 26.2
recreation, and
motion pictures
Medical and health 210| 1,708] 5,034 33.9
Business and personal 175| 3,173] 6,144 51.6
services
Hotel, lodging, 127| 2,680] 5,473 49.0
automotive
Unable to classify o| 2,002 | 15,317 13.1
Miscellaneous not Oo} 2,382 0.0
business and personal | available
services
Miscellaneous 294] 1,080] 5,496 19.7
services
Total* 2,514] 35,360] 152,534 23.2

“Totals may not add due to rounding.

Source: Final 1994 TCMP Sample Design.


94

information, the stress of being subjected to an IRS probe into all of his financial affairs
and the necessity of having to explain many non-tax related transactions to the satisfaction
of the examining agent. That last point was particul: ‘ly vexing to my client, He questioned
why he had to explain to the examiner why he refinanced his ski house. He never deducted
any portion of the ski house for his business. It was for the sole use and enjoyment of his
family and he felt it was none of the agent's business. My explanation that the agent had to
account for all deposits into his bank accounts during the period under examination to
insure that all income was properly reported merely served to further enrage him that his
honesty should be questioned about reporting his business income, When I recently told
him that the IRS will be conducting another TCMP this Fall his reaction was, in the words
of an old Irish ballad, “in a language that the clergy does not know.”

The Issue Before Us Today

The issue before us today is to consider if the traditional means of conducting
‘TCMPs are necessary in today’s business environment. Do we really need to single out
13,000 taxpayers later this year and subject them to such an invasive process? Are we
certain that we can't “reinvent” the TCMP process like so many other processes the IRS
has overhauled in the past few years?

There is a cultural change underway within the Internal Revenue Service. They
have begun to re-emphasize the traditional methods of auditing with their recent training
programs focusing on the economic reality of the taxpayer’s lifestyle if it is inconsistent
with the income level reflected on the tax return. This reflects the effort to question not
only deductions the taxpayer has taken but the income received and reported. While there
have been legitimate concerns raised about any wholesale implementation of this
approach, one can hardly fault tax administrators for attempting to identify taxpayers with
undisclosed income,

It is precisely with respect to this last point, identifying undisclosed income, where
‘we see the greatest weakness of the TCMP process, In a rudimentary sense, conducting a
‘TCMP is akin to “preaching to the choir.” It provides data about what compliant
taxpayers are deducting. It provides little in the way of identifying income never reflected
on the return and it provides nothing about taxpayers who never file. It is precisely the
problem of under-reporting and non-reporting of income that so fuels the average
taxpayer's frustration with the current tax system. Any voluntary compliance system
depends on the perception that everyone is paying their fair share. When it becomes
common knowledge that there are many members of the society not participating in the
system, it undermines the support for the system among those who do comply.

The Service has begun to focus on those segments who are not complying through
the use of the Market Segment Specialization Program. We believe this approach is a wise
cone and believe that compliance will result from approaching taxpayers on an industry
specific basis. Using a market driven approach also permits taxpayer education when
appropriate and identifies legislative changes which could increase compliance. The
Service clearly recognizes these factors and therefore an increasing number of returns
selected for examination are not being selected based on DIF formulas but because the
taxpayer is in a particular industry or fits a market segment profile. The Service has seen
the dramatic results of many of these market segment audit programs in the form of higher
deficiency amounts and increasing market sector compliance levels.

‘We believe that the DIF score will continue to decline as the primary selection

mode as the Service develops more market segment data and begins to reprogram its
resources into more productive examination areas. It is less and less important to maintain

and dispersed
Simpl, wat docs une othe Gulf Stes Distt beadquanerd ov New Oneas i
the Los Angeles District has a team assigned to the entertainment industry?


Planned Survey of 1994 Tax Retums

The planned survey of 1994 tax returns will, for the first time, combine the
four major return types -- individuals, corporations, partnerships, and S corporations.
In addition, for the first time, it will also include Foreign Controlled Corporations
(FCCs); giving us much needed data on FCCs. We will randomly select and
examine approximately 153,000 retums. These returns will be examined over a 30-
month period beginning in October 1995 and ending in March 1998. Data analysis
from this TCMP will provide better DIF formulas to select 1999 returns for
examination,

‘The 1994 TCMP is an integral part of the IRS’ new approach to identifying
and addressing noncompliance. This approach involves analyzing data by market
segments and geographic area; identifying compliance issues and causes of the
noncompliance; and recommending solutions to address the noncompliance.
Through analysis of TCMP data by market segment and geographic area, the IRS
will use education, outreach and focused enforcement activities in a way that
maximizes the impact on noncompliance. In addition, the data will provide better
information on noncompliance that can be corrected through legislation.

To implement this new approach, the sample design had to accommodate:

The need for statistically valid data by market segment and by
geographic area.

The need to trend newly gathered market segment data to past
reported income/asset level data.

The planned survey also incorporates different types of returns that had
previously been handled in separate surveys. The sample was designed to take
into account all of the following factors:

6 Return Types (Non-business Individual Returns, Sole Proprietor
Individual Returns, Corporate Returns, S Corporate Returns,
Partnerships, and Foreign Controlled Corporations);

30 Geographic Areas;

10 Reported income Level Categories for Individual Returns;
5 Reported Asset Level Categories for Corporate Returns; and

27 Market/industry Groupings.

Considering these factors, the 153,000 sample is only slightly larger than the
111,000 sample size for the previous surveys conducted. The 153,000 sample size
represents a filing population of over 123.9 million retums -- only about one-tenth of
‘one percent of the total filing population

In recent months, to ensure that the planned TCMP audits are of the highest
quality, the IRS has improved two of its examination tools -- case building and
market segment specialization program. Through the use of technology, the IRS
has greatly enhanced its capability for case building. To improve the efficiency of
our auditors and reduce the time it takes to perform an audit, before an examination
is started, we now build a more complete case file, including prior and subsequent
year tax retum data, copies of related information returns, and copies of currency
transaction documents. In the past, due to the limitations of our computer systems,
taxpayers were asked to provide copies of the prior and subsequent year returns for
the examiner to review. Because the examiner is better equipped and more familiar
with the taxpayer's overall tax situation, the taxpayer's time and cost of the
examination are minimized.

Also, to the extent possible, TCMP examinations will be assigned to market
segment specialists, examiners trained in the unique operating procedures, issues,
and applicable tax law specifically related to a particular business, group, industry or
profession. The market segment specialists are trained to identify and develop
industry specific issues. Also, because the specialists will perform audits of certain
groups there will be a high degree of consistency and uniformity in the treatment of
issues. Of equal importance, MSSP reduces burden, time and cost on the part of
taxpayers as a result of the examiner's increased understanding and knowledge of
the taxpayer's business and accounting procedures.

‘The examination phase of the upcoming survey is 30 months with
examinations beginning October 1995 and all examinations to be completed before



77

Testimony oft Dr. Malcolm K. Sparrow
John F. Kennedy School of Government
79 John F. Kennedy Straat
Cambridge, MA 02138
(Tel: 617-495-8359)

Before: House Committea on Ways and Means
Subcommittee on Oversight.
Date: Tuesday July 18th 1995

Thank you for the opportunity to address you this morning on tha
importance of the Taxpayer Compliance Monitoring Program.

Por the last six years T have been studying and writing about sone
very significant changes in the way American rogulatory and
enforcement agencies approach their business. Nany such agencies are
rejecting ‘their traditional ‘dependence on predictable procesee:
procedures, and "coverage", and are developing new capacities for
analyzing important patterns of noncompliance, prioritizing risks, and
designing intelligent interventions using a much broader range of
tools than traditional enforcement actions alone. Police Departments
call this emerging strategy "problem-solving policing". Environmental
agencies cally it "managing for environmental rcoults". OSHA now
calls it "the problen-selving approach to hazard mitigation". ‘the IRS
calls it “Compliane 2000",

under “Compliance 2000" the IRS proposes to develop its capacity
for identifying important patterns of tax non-compliance and designing
taiior-made, surgical interventions aimed at producing higher levelo
of compliance, problem area by problem area. That is the heart of
their "Compliance 2000" strategy, which is still under development.
It is a more analytical, nore intelligent, less enforcenent-oriented
approach to taxpayer compliance; which I Link we should all recognize
and welcone.

Such a strategy relies absolutely on the agency's ability to
recognize quickly, el patteriis of non-compliance

y energe from Tine to tize. Tne TeMP’forns a vitel ands T
Baiiews, spensable part of the monitoring apparatus.

‘The danger that TCMP helps the IRS avoid is a common one, facing
211 "compliance" or “regulatory” agencies: nanely the risk of assuming
that you know about, , all the inporcent patterns of non-

compliance, The vay these agencies can delude thenselves goes
something iixe this, You focus on what you think are tne central
problems. As you do so, you learn more and more about those problens,
and they yet more central in your thinking. as time passes,
you work on the non-compliance problems you know about; and you learn

more about the non-compliance problems you work on. You can
Ay gat caught in the circularity of this, focusing more and nore
carefully on things you alvays focused on before, just pecause th

‘the problems that happen to be in y: . You fish in the
same place, year after year, because ‘chee Pee Jere you caught fish



83

in the audit for her to notice that my living style might not match
what I had declared, and there is that possibility, I believe, even
within the line-by-line direction of the TCMP audits.

Chairman JOHNSON, Thank you. I am sorry that I must excuse
myself. I am going to recognize Mr. Laughlin and turn over the
gavel to my colleague, Mr. Hancock.

Mr. HANCOCK [presiding]. Mr. Laughlin.

Mr. LAUGHLIN. Thank you, Mr. Chairman.

Mr. Goldberg, in your testimony here today, you said there were
other far less costly and intrusive ways to develop estimates of at
least equal reliability. I first want to ask you what are the intru-
sive ways that concern you about the TCMP?

Mr. GOLDBERG. Mr. Laughlin, we are selecting 153,000 citizens,
taxpayers, businesses and asking them to provide a line-by-line jus-
tification of every item on their return. I can tell you, as a former
IRS Commissioner, I can tell you as a practicing attorney, and I
can tell you as a citizen, I guarantee you that is very intrusive.
That is a miserable experience.

I think that because the government does not have to pay the
freight——

rr. LAUGHLIN. Because the government does not have to what?

Mr. GOLDBERG . Because the government does not have to pay
the freight, it is pretty easy to forget what we are doing to the citi-
zen, ani that bothers me. It is an intrusive process and I do not
think anyone would dispute that.

Mr. LAUGHLIN. I want to ask you from that same testimony if
you could identify some less costly methods and intrusive methods
for obtaining the information that is sought.

Mr. GOLDBERG. It depends on which objective. If you are talking
about tax &e estimates, people can make tax gap estimates relying
on many different data sources. TCMP is a piece of that, but there
are other ways to make those estimates.

I am not a statistician, but, as I mentioned, Dr. Scheuren is, I
believe that Dr. Smith is. The experts I talked to when I was the
Commissioner led me to conclude that on an all-in basis, the sys-
tem would be far better served through far smaller samples, orders
of magnitude smaller with annual kinds of examinations being con-
ducted. I believe that would be a far more effective approach. The
$550 million of taxpayers’ money is a lot, and I am not convinced
that the additional accuracy of any TCMP tax gap estimate is
worth the cost.

Mr. LAUGHLIN. The reason I ask about the intrusive ways, I have
those concerns, too. You stated that you estimate out-of-pocket cost
to the taxpayer to be in the $5,000 to $10,000 range. My question
is what expenses were used in reaching these estimates that you
made?

Mr. GOLDBERG. It was like that. There is no data. All I can tell
you is that 60,000 of these audits are going to involve partnerships
and corporations, another 50,000 to 60,000 are going to involve tax-
payers with schedules C, F, D, and at least in my—I believe those
numbers are probably low. But one of the things that I find rather
striking is that, in light of all this discussion, I do not believe that
the TCMP audit itself even gets information on how much tax-
payers spend in the process.


5

I welcome the witnesses today and thank you for your willing-
ness to testify on these issues. Let us start with Phil Brand, the
Chief Compliance Officer of the IRS.

Mr. Brand.

STATEMENT OF PHIL BRAND, CHIEF COMPLIANCE OFFICER,
INTERNAL REVENUE SERVICE

Mr. BRAND. Madam Chairman and distinguished members of the
subcommittee, I appreciate the opportunity to appear before the
subcommittee to discuss IRS’ Taxpayer Compliance Measurement
Program in general; as well as our planned TCMP survey of the
1994 tax returns. I have a written statement I request to be en-
tered into the record which I will now summarize.

Chairman JOHNSON. Without objection, Mr. Brand.

Mr. BRAND. The first TCMP surveys were conducted in 1963 and
1964. One of these first surveys involved the examination of 1963
individual forms 1040 tax returns. Data from this survey was used
to develop the sophisticated computerized system to select individ-
ual and small corporate returns for examination. This system is
still in use today. It is called discriminant function or DIF.

DIF benefits taxpayers by significantly reducing the examina-
tions resulting in no change to the tax liability purported by the
taxpayer. In fiscal year 1969, prior to the use of DIF, 46 percent
of the examinations that we conducted resulted in no change to the
tax reported by the taxpayer. In 1994, only 15 percent of returns
selected for examination using DIF resulted in no change to tax re-
turns.

This means that a significant number of taxpayers, who have
correctly and accurately filed their returns, are not burdened with
examinations.

Over the past 30 years, IRS has conducted 25 TCMP surveys of
various types of returns. In all these surveys we have focused on
specific segments of the taxpaying population—individuals, cor-
porations, partnerships and S corporations—one segment at a time
over a 7- to B-year time period. These surveys were designed to pro-
vide statistically valid data on compliance levels by return type and
by reported income and asset level at the national and regional
level.

Since the data from these surveys is 7 to 14 years old, the IRS
is selecting returns for examination and allocating resources based
on data that is not current. New data that is statistically valid by
market segment and geographical area is critical to enable us to
focus our compliance efforts on the most noncompliant taxpayers.

The plan survey for 1994 tax returns will, for the first time, com-
bine the four major return types—individuals, corporations, part-
nerships, and S corporations. In addition, for the first time, it will
also include foreign-controlled corporations giving us much needed
data on FCCs. We will randomly select and examine approximately
153,000 returns.

The 1994 TCMP is an integral part of the IRS’ new approach to
identify and address noncompliance. This approach involves ana-
lyzing data by market segments and geographical area, identifying
compliance issues, causes for noncompliance, and recommending
solutions to address the noncompliance.


111

STATEMENT OF FREDERICK (FRITZ) SCHEUREN, PHD.,
VISITING PROFESSOR OF STATISTICS, GEORGE
WASHINGTON UNIVERSITY, WASHINGTON, D.C. AND
FORMER DIRECTOR, STATISTICS OF INCOME DIVISION,
NTERNAL REVENUE SERVICE

Mr. SCHEUREN. I am a former IRS employee, but I have been out
of the Service now for a few months and I am teaching at George
Washington University. I am not going to cover my testimony in
any depth, except I would like to talk about possible alternatives
to the specific 1994 proposal that you heard about this morning.

I feel that there are a number of issues around that proposal, or-
ganizational issues around the way the Service is planning to do
it—considering the way it has done it traditionally.

There are also some operational concerns with such a large en-
deavor, and I have recommended in the testimony that the Service
conduct a “dress rehearsal” this year, instead of a full-scale study.
This is a very large undertaking and dress rehearsals are typical
in large statistical efforts. The Census Bureau, for example, typi-
cally conducts one or more dress rehearsals before each census. We
are talking about something that is on that order of magnitude.
This is a very large undertaking, and I think it deserves a dress
rehearsal, especially given the things I heard this morning about
the computer system.

I also want to comment about the sample design, since that is
my business. In general, the work done on the sample design was
extremely good, although it is constrained by some assumptions
that were made. I think that there are some issues around the data
available to do the sampling with—given the antiquated nature of
the IRS processing system.

I would recommend a change in the way that the sampling is
going to be carried out for 1994, if a pilot or a dress rehearsal were
taken. My approach would be quite simple. Just take the existing
sample that has been drawn, which as I say is quite good, given
the constraints, and subsample it to deal with some of the burden
issues and with some of the targeting issues and with the point
that we really need a dress rehearsal. Then field a sample of, per-
haps, 15,000.

Now, admittedly 15,000 is a number that I pulled out of the air;
but it is a significantly smaller number, an order of magnitude
smaller than 150,000. You cannot settle these questions, at least in
my business, without doing some empirical work. I am not sitting
here saying I have done this empirical work. It requires a lot of
study. But I think a small, but not too small, version of what is
planned is what is appropriate.

I think there are some issues about sample estimation and Fred
Goldberg made some of these points this morning in a general way
and I will make them again. I think things have moved, in my pro-
fession, in the last 30 years a great deal, and I think there are
ways that we can more efficiently make estimates from a sample.
That efficiency could lead to a smaller sample.

I do not want to overpromise here. I know a great many of these
new methods are worth trying and some of them have actually
worked. A TCMP study that I was slightly involved in (form


81

1 understand the overall logic of the IRS’ taxpayer compliance pro-
m. It is instructive that it does not touch on the biggest revenue
loss area and that is unreported income.

Is there a program that the IRS could and should be developing
to find out how they could better track all the cash economy that
the current system is incapable of reaching? This is probably the
most important issue that we face right now, because we are about.
to change our entire Tax Code in part to reach the unreported in-
come.

One does have to question spending $550 million to refine the
structure we have, when one of the reasons for totally changing it
is that so many are not complying, and this will not reach them.
Now, is there any way we can design a program that might find
out how people are avoiding reporting and what can we do about
it’

Mr. GOLDBERG. Madam Chairman, with all due respect, I believe
that you are going through exactly the process that the Internal
Revenue Service should be going through. You have stated a hy-

thesis. It is correct, in my judgment. Unreported income is the

iggest single problem in the system.

e next question, can we design a research program that will
allow us, No. 1, to understand the magnitude of that problem, and,
No. 2, design the research program in a way that will give you an-
swers you care about, give you answers that you can do something
with. I believe the answer to that question is unambiguously yes,
I believe that could be accomplished. I believe it could be both ac-
complished and educated in a fraction of the time required for
TCMP, and I believe that the information you would derive would
be far more reliable.

Mr. GiBBons. Madam Chairman, I would like to respond. It. is in-
teresting that you raise that. You are going to have another wit-
ness later on in this testimony, Dr. Kent Smith, that was respon-
sible for the largest study I know of on noncompliance in the tax
area. It was sponsored by the American Bar Association.

There have been proposals. There have been a lot of proposals
over the last 20 years as to how we detect, what we do to measure,
and how we prevent the problems that are going on in the cash
economy. This gets back to my fundamental point: To tell me that
you will promise me that if I will agree to give up something, you
will find something for me that will do this, my reaction is why not

‘ive it to me now and let me compare it against what I have before

give it up. Because for the last 20 years, we have not done a very
good job. We have known the problem was out there, it has been
studied and we still do not have something that people can agree
on a broad basis will be appropriate to measure, detect, and pre-
vent the problems in the cash economy.

Mr. GOLDBERG. Madam Chairman, I would just like to point
out—and I have not discussed this with Dr. Smith, and I could be
mischaracterizing his testimony—I believe his recommendations in
essence, at least as I read it, that it may well be prudent to move
to far smaller sample sizes and to conduct TCMP examinations on
an annual basis. I believe that is also Dr. Scheuren’s recommenda-
tion, and it is my recommendation, as well.

Chairman JOHNSON. Thank you.


107

solved in a sense, in the taxpayer’s favor and that the auditor’s ad-
justment is not the final figure. In fact, it is a figure that is a com-
promise between where the taxpayer might have been and where
the auditor was. Is that what you are saying?

Mr. KEATING. Yes.

Mr. PoRTMAN. In other words, the fact that 97 percent of them
are worked out I suppose would indicate that folks understand the
litigation costs, as you said, or they can understand the cost benefit
analysis and they are willing to work on resolving it by going to
another level than where the audit had been?

Mr. KEATING. Well, certainly that is a factor but also I have
heard a number of reports from our members that it is simply that
there is a better level of understanding at the appeals process and
more willingness to consider things that you do not see considered
at the auditing level.

Mr. LANE. Could I add something here?

Mr. PorTMAN. Sure, please.

Mr. LANE. I do a fair amount of appeals work myself. I do not
know how valid that number is.

Mr. PorTMAN. The 97-percent number or the——

Mr. LANE. Oh, I believe 97 percent settle, but I do not think it
is all settled at less than the tax auditor or the revenue agent pro-
posed. There are a number of ways that cases get to appeals. The
important difference with appeals as opposed to a tax auditor in
the office or a revenue agent in the field is that the Service has
given the appeals office settlement authority in cases.

The people on the street do not have settlement authority. Their
job is to make the substantially correct tax liability based on their
understanding of the law. They are not allowed to consider the haz-
ards of litigation and for good reason. You would not want to have
25,000 employees across the United States all having their own
view of what is the hazard of litigation. It is a lot easier to control
1,900 appeals officers.

Because settlement authority is not provided to those employees
and it is provided to the appeals office, they have more flexibility
in resolving cases.

An awful lot of stuff that goes to appeals gets there by default.
For example, the taxpayer may have moved and did not get the
audit notice and the next thing they know they get a statutory no-
tice of deficiency, or they have a deficiency assessment and they go
in and say, well, I really have got proof of my home mortgage inter-
est and my charitable contributions, so appeals opens that case up
and resolves it.

Other appeals cases may be Tax Court cases never really in-
tended to go to Tax Court. They are filed to preserve the taxpayer's
ability to appeal the audit process. So a lot of “junk,” that is, sub-
stantiation and documentation cases, get into appeals for resolution
which should have been closed further down in the process.

Clearly, the better people in IRS, in terms of their technical
knowledge, are in the appeals function. For one thing the grades
are higher, the work is better. You do not have an inventory to
carry that is the size of the field inventories, and it is a nicer envi-
ronment to work in. So the better people that have settlement in
mind tend to gravitate toward that work.


92

We would like to see a cost benefit analysis done of this whole
program. I heard today that this is going to cost $2.1 billion and
some 30 or 40 percent of the people selected are going to be inno-
cent bystanders. I think $2.1 billion could be spent in a much more
effective way.

We also would like to see taxpayers compensated for the amount
of time it takes and for the cost of representation. I think Mr. Gold-
berg’s projection of $5,000 to $10,000 is on the low side for the cost
of representation if you are a corporation or a partnership going
through this, this type of audit this year.

We would be happy to take any additional questions you have.

[The prepared statement follows:]


60

A third point is that the TCMP data facilitates the development
of compliance legislation. Others have cited examples ranging from
toys for tots to alimony reporting to State income tax refund re-
porting. I believe that in each and every one of those instances, the
same results could have been accomplished at a tiny fraction of the
cost and far more rapidly, if folks had sat around and thought care-
fully about the tax system, and the process of thought, reflection,
contemplation would have led to those results far more effectively.
TCMP was useful as a revenue estimating device, but I think that
is the end of it.

Tax cap studies, again I question their value. I also question
whether $550 million of the taxpayers’ money, more than $1 billion
of our citizens’ out-of-pocket costs and hundreds of millions of
hours, is worth whatever improvements could be achieved.

I think it is time to start over. TCMP served an invaluable pur-
pose 25 years ago, but we are trying to retrofit a battleship and
turn it into a speed boat. That effort is doomed, in my judgment,
to fail.

I believe if I could commend you to one piece of testimony, it is
not my own, it is Dr. Scheuren’s testimony. I have known Fritz for
years. I was unaware that he was going to testify today. I believe
that he provides a practical, workable alternative that is far less
expensive, far less intrusive, and will provide far more valuable re-
sults.

Thank you very much.

[The prepared statement follows:]


56

taxpayers a “hotline” number to assist them in handling tax problems that
occur for the next couple of years, (iv) waiving certain penalties or
interest, or even tax, and (v) granting even more extreme waivers to
cooperative non-compliant taxpayers. The Subgroup is not endorsing any
of these suggestions at this time but remains concemed about the burden
that TCMP imposes on taxpayers, especially those who are found to have
substantially complied with the law. The Service should continue to study
this issue.”

D. THE TCMP Process

Question 1: Do both TIES and the backup data collection systems collect
detailed information on the “other” categories of income and expenses?

Answer: No. The new TCMP checksheet portion of TIES is designed to allow for one
issue to be captured per line item with a causal code and Uniform Issue Listing (UIL)
code to be attributed to the largest issue, if multiple issues are present. The backup
data collection system, Electronic Data Gathering for Examination (EDGE), is similarly
designed. The TIES workcenter, however, normally allows for writing a Revenue Agent
Report (RAR) that accounts for multiple issues related to a single line item.

Question 2: Will the detailed information on the "other" categories of income and
expenses be recorded in the TCMP database for purposes of analysis?

Answer: No. The database that will capture and archive the TCMP results is not
designed to display multiple adjustments per line item. The file transfer, data diskette
creation, and data accumulation programs are likewise not designed to address multiple
adjustments per line iter. It is our intent to capture the causal code and UIL code for
the largest adjustment to an “other* line item. It is important to note that this capture
methodology is a vast improvement over prior TCMP surveys. In prior surveys, no
information on causal codes or UIL codes was captured.

If there is interest in analyzing instances where multiple adjustments occur on an
“other line item on a retum, we will be able to determine when multiple adjustments
were made to a line item by analyzing the comments section of the TCMP file which will
be available in computer sensible format on the TCMP file at the conclusion of the
survey.


18

the type of return they file. IRS plans to stratify the sampled
returns into 24 business (including one on foreign controlled
corporations) and 3 nonbusiness (individual) market segments.

IRS believes that stratifying the sample in this manner will
allow it to more effectively use TCMP data for identifying
noncompliance trends and selecting cases for audit. To ensure
comparability with previous TCMP surveys, the sample can also be
analyzed in the groupings used in prior TCMP surveys (i.e., by
return type, assets, and income). (Appendix II shows the number
of sampled cases and estimated number of taxpayers in each market
segment.)

IRS also plans to provide its auditors more information on each
sample case than in the past. Auditors are to receive 3 years of
tax returns (1994 and the two prior years), third-party
information returns, and other taxpayer~specific data. Also,
District Office Research and Analysis sites are to provide
industry-specific profiles for each market segment in their
geographical areas. IRS believes that this additional
information will help auditors better plan their audits and
reduce taxpayer burden by requesting only those taxpayer records
that are needed for the audit. This additional information
should also improve the results, and thus the value, of TCMP
audits.

Unlike in prior surveys, in the 1994 TCMP auditors will try to
identify and record the cause of noncompliance and the related
tax issues. Knowing the specific tax issues involved and
understanding the reasons for noncompliance will help IRS develop
cost-effective ways to improve compliance.

IRS is emphasizing quality audits in this TCMP and is training
auditors on how to spot potential noncompliant behavior in
specific market segments. IRS has also modified its quality
review program to help ensure quality audits. In past TCMP
surveys, quality control was left largely to line supervisors.
For the 1994 survey, IRS plans to have a three-tier quality
control program, in addition to supervisory review. In the first
tier, an "in-process" review team will review audit workpapers on
a sample basis while the audits are still under way to help
ensure that auditors are doing quality audits. For the second
tier, audit managers will review each case prior to closure.
Finally, IRS’ audit quality review group will review a sample of
closed cai In addition, the District Office Research and
Analysis sites plan to review data entered onto the TCMP database
for input accuracy.

In past TCMP surveys, IRS concentrated primarily on income tax
issues. In the 1994 survey, employment taxes will receive more
attention. Examiners will be told to refer businesses that
appear to be in violation of employment tax regulations to
employment tax auditors. Information from these audits will also


AT

But after someone has gone through all of this process, is there
any talk about compensating people who in the end are found to
have been fully in compliance and have cooperated with the IRS in
this effort?

Mr. BRAND. Mr. Portman, the discussion has been external.
There has not been internal discussion. We have done some esti-
mates based on ‘the fact that we know the issue has been raised
and is a question. Really, it is a question more appropriately an-
swered by Treasury, as opposed to IRS, I believe, because I believe
it enters into the realm of tax policy.

Mr. PorTMAN. That is fine. I guess my final comment would be
that we would appreciate, certainly I would, any information you
have on just the average time you think this will entail based on
previous audits. Although I know there have not been audits of this
type of looking at the economic realities, and then the cost, the cost.
to taxpayers, just so we know that up front and we can deal with
that issue.

I appreciate your testimony this morning.

Ms. STATHIS. Mr. Portman, it will not make the person who is
involved in a TCMP audit feel any better, but if the IRS auditors
were not doing a TCMP audit, they would be doing more of other
kinds of audits. So, in a way, the burden may not be that different
in total. It just is distributed differently and the people who are in-
volved in the TCMP audits are going to bear more of that burden
than they would otherwise.

Chairman JOHNSON. Before I recognize Mr. Herger, let me just
comment that this subcommittee will be looking at compensation
and we do hope that you will get your opinions back to us, because
the people who are the object of ordinary audits, in a sense, have
done something to trigger that. It does not mean that they are
wrong, but there is something about their return that triggers the
attention of the professional in the IRS. These folks are selected at
random and may be in substantial compliance, and for the majority
there is no change. I think there is an equity issue here and we
do want to look at that, and I appreciate the gentleman from Ohio
raising it.

Ms. SraTHIs. There is a committee of the Commissioner’s advi-
sory group that has explored this issue and you may want to chat
with some of them.

Chairman JOHNSON. We will check with them. Thank you for
that comment. I was not aware they were doing that.

Mr. Herger.

Mr. HERGER. Thank you, Madam Chair.

Mr. Brand, GAO has raised a concern that no effort has been
made to retain auditors’ workpapers in an accessible format for
purposes of more detailed research. I am just wondering, is such
data useful and, if so, are any steps being taken to make the data
available?

Mr. BRAND. We are hopeful that the electronic gathering of infor-
mation will do that and we will be able to more readily use those
workpapers and gather them. That is a fairly awesome task, as you
can imagine, because the electronic gathering of information is a
summary of changes, data, and information, while the workpapers


51

The point we were making is that the TIES system IRS is hoping
to use provides a lot of information on those details, and we are
just hopeful that IRS will figure out a way to include that informa-
tion in the TCMP data base. Otherwise, it will only be in the
workpapers and somebody will have to go back and search through
them. Even if the information is computerized, searching will still
be necessary to find it. So I think it is really important in under-
standing the total picture to be able to have that information in the
TCMP data base.

Chairman JOHNSON. Mr. Brand.

Mr. BRAND. I would echo that, and it is our intention to make
sure we understand that area.

Chairman JOHNSON. There are two programs that you have de-
veloped, your primary computer program and_your backup com-
puter program. Did they allow for further detail being included in
the other category?

Mr. BRAND. I would like to provide that for the record to make
sure of that answer.

Chairman Jounson. Thank you.

Last, the issue of appeals, what is the average number of appeals
under the normal audit program, and in what percentage of those
appeals is the taxpayer's liability reduced?

Mr. BRAND. I would like to provide that for the record, too,
Madam Chairman.

(The following was subsequently received:}


80

ciencies in any process or procedure. But, Madam Chairman, it is
the best form that we have and I think it is credible.

One of the things that I said in my testimony that I would like
to reiterate here, one of the things about the TCMP type approach
is that taxpayers across the country can at least understand it. It
is not an abstract statistical, it is not an abstract economic, it is
not an abstract social science type of theory.

At least at the bottom of it, people can understand and relate to
an audit. They can understand and relate to using a bunch of au-
dits as statistical samples on a periodic basis to measure compli-
ance and see how much we are losing. I think that is really impor-
tant in terms of people understanding and, therefore, having a
method that seems credible across the country.

So almost anything you come up with is going to have short-
comings. You can criticize various aspects of it. But if it has a basic
ring of truth, until we come up with something that is better, my
reaction is it is something that we ought to continue to refine and
improve, but we ought not to abandon it. So I would respond to you
by saying you may be able to pick at it and show one place where
it did not work, one thing that is wrong with it or those types of
things. But overall it is better than anything that anyone has pro-
posed as an alternative.

Chairman JOHNSON. Mr. Goldberg.

Mr. GOLDBERG. I am tempted just to rest my case. Madam Chair-
man, I think that the problem we are having here is TCMP, to the
extent what you are saying is random sampling is important, I ab-
solutely agree. To the extent you are saying measures of the tax
gap are important, I am not quite as convinced, but that is an OK
thing to do.

My testimony is directed toward the proposed 1994 TCMP. I do
not believe that the additional reliability, if any, with respect to tax
fee estimates that will come out of that program is worth anythin;
ike $550 million in taxpayer money, more than $1 billion oj
out-of-pocket expenses by our citizens, and hundreds of millions of
hours of time and torment. I do not think it is worth it. I believe
that you can get approximately accurate tax gap estimates far
more efficiently and far more effectively in other ways.

Dr. Sparrow referred to circularity. I believe he is describing an
important phenomenon, but I believe the circularity is that the IRS
for 35 years has been taking these enormous samples and running
these so-called TCMP audits on intervals ranging from 3 to 10
years. The circularity is that the IRS is afraid to Tet go. We have
always done this, so we know this is the only way to do it. That
is the circularity.

The IRS, I am absolutely convinced, could accomplish its objec-
tives, could deal with tax gap measures, could deal with detecting
trends of noncompliance, could deal with coming up with respon-
sive answers to Members of Congress who are considering anything
from EITC compliance legislation to fundamental tax reform
through a system that was designed in a fundamentally different
fashion. At the end of the day, it will rely on random selection, but
you can do a lot better for a lot less. Why not?

Chairman JOHNSON. Certainly the benefit of targeted studies is
demonstrated by Dr. Sparrow’s really excellent work on the EITC.


142

Congress of the United States

JOINT COMMITTEE ON TAXATION

ington, WC 20515-6453 AUG 0 1 1995

Honorable Nancy Johnson
U.S. House of Representatives

The Joint Committee uses the TCMP data in preparing revenue

estimates.

1)

2)

3)

4)

5)

6)

7)

8)

Some examples of these include:

To segregate the "Other Income" line item into the
sources Of income reported. The General Accounting
Office performed this analysis for the Joint Committee
and provided results that were used to estimate
gambling reporting proposals.

To estimate excessive claims of charitable
contributions for various information reporting
proposals. In particular, TCMP data was used to
estimate the charitable contribution substantiation and
disclosure requirements included in OBRA 1993.

To analyze estimated tax payment relief proposals for
individuals in disaster areas.

To estimate the reporting of disability income
payments.

To estimate the reporting of unemployment income
payments.

To estimate real estate and property tax reporting
proposals.

To analyze information reporting of sole proprietor
gross receipts, and sources of sole proprietor
noncompliance, by line item and occupational
category. This information was very useful in
estimating both the Administration's Service Industry
Noncompliance ("SINC") proposal in 1993 ahd, more
recently, various independent contractor proposals.

To analyze the relative compliance of different classes
of taxpayers for various tax reform proposals.

I hope that this information is helpful to you. If we can
be of further assistance in this matter, please let me know.

UY | 4
Kenneth $. Goes


185

payers. Asa consequence, we must have adequate samples within these categories to permit
stable estimates at the level of detail needed for audit selection models and other types of
analyses. The added focus on geographically specific analyses by the DORA sites is in many
respects a significant improvement, but it does add another cross-cutting dimension for strati-
fying the population of returns and may increase the total sample size needed.

Burden on Taxpayers. Audits, undertaken for whatever reasons, are burdensome and anxious
experiences which taxpayers would like to avoid. TCMP audits differ from other general
audits because there is a higher probability that the audit will result in no change or a refund.
‘On the other hand, many retums selected through the sampling process end up with taxes
owed even though there was no indication ahead of time that there would be noncompliance.
In that respect, all TCMP audits are enforcement audits.

Is the burden in principle excessive or unreasonable? Here I think my analysis of Oregon
state audits is relevant. Most of the audits I studied were general audits that routinely in-
cluded deposit analyses or other indirect methods for checking income. In many cases, tax-
payers were also asked to complete a form with estimates of their annual personal and house-
hold expenses. Audits that began with one focus frequently expanded to other issues and to
other years’ returns. Not unlike TCMP audits by the IRS. Did taxpayers in Oregon consider
them to be burdensome? Yes. But the vast majority we interviewed did not consider them
unreasonably burdensome and, by and large, the taxpayers came out of the audits feeling
satisfied with the process and how they were treated and satisfied with the outcomes.

From this analysis and other research on citizens’ responses to enforcement experiences, 1
‘am convinced that the primary focus in improving taxpayers’ responses to TCMP audits
should be on assuring that the auditors appear competent, efficient, and reasonable; treat the
taxpayers with respect and dignity; keep the taxpayers informed on the progress of the audit;
and explain both the process and the decisions in clear and understandable terms. Without
assuring the quality of these fundamental fairness aspects of the process, some taxpayers are
going to continue to be alienated and resentful, even if they are paid. In short, I am not per-
suaded that paying taxpayers is necessary, and I am concerned that payment without assuring
quality may have unexpected and not necessarily beneficial consequences.

Yes, there are cases of excessive and unreasonable requests from auditors doing TCMP
audits. For instance, even in a general audit focusing on all relevant aspects of a taxpayer's
financial situation, there seldom is a need for a wedding certificate to verify that a couple with
children and grandchildren can be filing a joint return. But I think thoroughness and a focus
on the finances of a taxpayer, not just on what appears problematic on the return, is reason-
able in any audit—provided the audit is done responsibly and with respect and consideration
for the taxpayer. .

AAs is well known at least anecdotally, many auditors resent doing TCMP audits, and the
normal criteria for evaluating performance and allocating work in Examinations reinforce the
feeling that TCMP audits are also an unreasonable burden on auditors. I suspect that many of
the horror stories about taxpayers’ experiences can be traced to what can be called “over-con-
formity” and excessively going by the book on the part of resentful and alienated auditors. In
social science and medical research, there is always a concern about the quality of data one
can obtain from “hired-hand help” who do not understand and are not committed to the goals
and procedures of the research. In improving TCMP, more attention needs to be placed on
assuring that auditors are not alienated, hired-hand help. They are the lynchpin of the pro-
‘gram and have to be committed team participants.

Some Suggestions for Possible Improvements

In light of these observations about the issues surrounding TCMP, let me briefly suggest
some possible improvements. All have been suggested before by experts inside and outside
the Service, and I think they are worthy of a serious and open-minded appraisal of their possi-
ble advantages and disadvantages.

Specialists in TCMP Audits. Examinations is increasingly moving toward various types of
specialists and specifically focused teams. These specialists often become resources for oth-


13

Some of the steps most critical to the success of this TCMP are
scheduled to occur within the next several months. These include
testing a computerized data collection system and training the
auditors who will do the TCMP audits. If the planned data collec-
tion system does not work, IRS has developed a backup system but.
it has fewer capabilities. Even if the planned system does work,
IRS currently does not have enough computers for all of the audi-
tors to use the system. That problem needs to be resolved to make
the results more useful for compliance research.

IRS also needs to modify the TCMP data base to make available
all of the data that the data collection system can provide and to
work on computerizing the audit workpapers so that they will be
more readily available to researchers.

With that, I will conclude my oral statement and be pleased to
answer your questions,

[The prepared statement and attachments follow:]


137

Mr. Hancock. Thank you, Dr. Smith.

The gentleman from Texas.

Mr. LAUGHLIN. Thank you, Mr. Chairman.

Mr. Scheuren, in your testimony you contended that the market
segment stratification is a good idea, but not fully tested. Has there
not been some market segment analysis of data from prior TCMP
studies that supports the value of such data from a larger sample?

Mr. SCHEUREN. I think the market segment is a very good idea.
The problem is at the point of sampling, how good a classification
of the taxpayer can you do in terms of market segments? There are
some real data quality problems on the tax returns that are being
used to do the sampling.

It is a well-known problem. A problem I actually worked on when
I was in the Service. At the point of sampling, there is a lot of pos-
sibility for misclassification.

That is one of the reasons why I recommended the additional
work of drawing a subsample.

Mr. LAUGHLIN. Ms. Long, you have indicated that there are nu-
merous approaches to address IRS concerns about the release of
current TCMP microdata. Could you give some samples of the is-
sues and the means of addressing them?

Ms. LoNG. Well, for example, IRS does release TCMP to out-
siders under contract with the IRS. You sign a disclosure agree-
ment with some restrictions. They might consider, in the short run,
such a proposal so that they could release data for purposes of re-
search. Their concerns, as I understand them, which I think are
somewhat misplaced, are that if you had the data you could recre-
ate their discriminant function formulas.

I think if you gave the data to 10 statisticians, you would get 10
different sets of formulas. I do not think this is a real concern, but
if that was a concern they could have contractual arrangements so
that people agreed not to do certain things.

I also think that there are some statistical ways that the data
could be sanitized that could provide protection against those kinds
of concerns with some of the new modern techniques that are avail-
able. Right now, TCMP, although we invest a lot of money in it,
the actual use of TCMP is disappointing. Also, IRS tends to be
rather insular in its approach. We need, I think, a wider commu-
nity looking at it.

Mr. LAUGHLIN. Dr. Long, and Dr. Scheuren, I apologize for not
acknowledging your academic achievement. Dr. Feinstein, in your
testimony you question the need to expand the household compo-
nent of the TCMP. Yet, you describe prior TCMP as thin for certain
groups and locales. Are there any differences in compliance based
on different parts of the country and, if so, are you saying that the
differences are not substantial enough to warrant the additional
audits, or that the past number of audits provide reliable data for
the selection of returns at the local level?

Mr. FEINSTEIN. In my experience, looking at the past data, you
would find in narrow cells of taxpayers, for example, farmers in a
particular State or lawyers in a particular State, perhaps 1 dozen
or 2 dozen TCMP audits.

I would say that that is, as a statistician would tell you, just
about at the level at which you can have some reliability in what


55

Question 4: What percentage of those cases resulted in a reduction of the
taxpayer's Ilability?

Answer: The Appeals follow-up information has not been perfected. Therefore, we
cannot directly measure the appeals sustension rate. Howaver, since the appeal rates

for the last two TCMP surveys are very low, we feel that the sustension rate is not a
significant issue.

C. ADDRESSING TAXPAYER BURDEN

Question 1: Given the number of issues and the higher standard of
documentation that taxpayers must meet in responding to a TCMP audit, how can

the resulting inequity in adjustments between TCMP audits and non-TCMP audits
be addressed?

Answer: The TCMP process does not increase the depth of the audit. As is normal
operations, examiners are directed to use good judgement in investigating issues. In
the TCMP process, examiners are directed to “consider” each line item. That does not
mean that each line item must be investigated, and an adjustment resulting in additional
tax does not have to be made if the adjustment is a small dollar amount. This is the
same expectation as in other audits. However, in a TCMP audit, the adjustment is
recorded on a checksheet regardless of whether the adjustment is made to the
taxpayer. TCMP results often point to the fact that smalll dollar value compliance
issues, if widespread enough, can amount to large compliance problems.

Question 2: What are the recommendations of the Commissioner's Advisory
Group committee that studies the issue of taxpayer compensation for
participation In TCMP audits?

Answer: The following is excerpted from the meeting minutes of the Compliance
Subgroup of the Commissioner's Advisory Group for February 1, 1994:

*..reducing unnecessary burdens on taxpayers should be an important
priority. There is a high level of no-change audits under TCMP because
of the random selection of returns. These taxpayers are participating in a
research project that has substantial benefits for the tax system as a
whole. Many of the people the Subgroup members spoke to, both inside
and outside the Service, felt that there should be a clear recognition of
this in the way that the TCMP audits are handled, The Subgroup heard a
complete spectrum of views on this -- (i) treating TCMP audits like any
other audit, even for compliant taxpayers, (ii) reimbursing compliant
taxpayers for some portion of the cost of the audit, (iii) giving participating


ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS
SUBCOMMITTEE ON OVERSIGHT

FOR IMMEDIATE RELEASE CONTACT: (202) 225-7601
July 10, 1995
OV-10
on Ann i ii
on the Internal Revenue Service’s

Congresswoman Nancy L. Johnson (R-CT), Chairman of the Subcommittee on
Oversight of the Committee on Ways and Means, ioday announced that the Subcommittee will
conduct a hearing to examine the Internal Revenue Service’s (IRS) plans to implement a study
of 1994 income tax returns through its Taxpayer Compliance Measurement Program (TCMP).
The hearing will take place on Tuesday, July 18, 1995, in room B-318 of the

Rayburn House Office Building, beginning at 10:00 a.m.

This hearing will feature invited witnesses only. In view of the limited time available
to hear witnesses, the Subcommittee will not be able to accommodate requests to testify other
than from those who are invited. Those persons and organizations not scheduled for an oral
appearance are welcome to submit written statements for the record of the hearing.

BACKGROUND:

Sound tax policy and administrative decisions depend on comprehensive, reliable, and
timely information on the level of taxpayer compliance with existing tax laws, For 30 years,
the TCMP has deen the IRS’s primary program for gathering such information. The IRS
collects TCMP data by auditing a random sample of taxpayers’ returns in which every line on
the return is examined,

In addition to measuring compliance levels, the data is used for estimating the tax gap
(ie., the difference between the amount of income tax owed and the amount voluntarily paid),
developing formulas for objectively selecting returns for audit, allocating the IRS’s audit
resources, analyzing specific compliance issues, and developing legislative proposals designed
to improve taxpayer compliance. Congress and federal and state agencies also use TCMP
data for policy analysis, revenue estimating, and research.

Beginning in November, the IRS plans to conduct TCMP audits of approximately
150,000 tax returns filed by individuals, small corporations, partnerships and S corporations
for tax year 1994. Compliance characteristics will be analyzed and measured within three
groupings of individual taxpayers and within 24 industry categories at both the national and
smaller geographic levels.

‘Some believe that TCMP studies are too costly, 100 time consuming and too
burdensome for the taxpayers involved. The IRS must use extensive resources to audit the
tax retums selected for analysis, The length of time it takes to plan, implement, analyze and
report on TCMP surveys results in a lack of timeliness in the availability of the information
gathered. In addtion, the burden placed on taxpayers who are the subject of these special
audits is substantial. The need to present documentation on every item on a return is
laborious and the necessity of discussing issues the taxpayer did not report or claim can be
confusing. For those who hire a professional to assist them, there can be a substantial dollar
cost involved. And finally, the audits are seen as unfair for those who have fully complied
with the tax laws and would not otherwise be the subject of an audit,

(MORE)


12

‘STATEMENT OF HON. LAWRENCE B. GIBBS
PARTNER, MILLER & CHEVALIER

Madam Chairman and Members of the Subcommittee:
I appreciate the opportunity to submit this statement in
connection with this hearing to examine the Taxpayer Compliance

Measurement Program of the Internal Revenue Service. I served as

Commissioner of Internal Revenue from 1986 until 1989, and I
presently am a member of the law firm of Miller & Chevalier in
Washington, D.c.

I add my congratulations to those of others on your
decision to hold this hearing to examine the IRS’ TCMP because I
believe that it is timely and important to examine this program at
the present time. Good questions are being asked about the

Program, and suggestions are being made to improve its

effectiveness. In this process I believe the TCMP, taxpayer
compliance, and our overall tax system wil] benefit.
The TCMP has been in effect for over thirty years.

During that time it has grown and changed to accommodate the needs
of the IRS, Treasury, Congress and others who have had an interest
in improving tax administration and the compliance with our tax

laws. Although TCMP has its drawbacks and its limitations, it is

the only comprehensive and reliable method to determine taxpayer
compliance that has been devised and has been able to withstand the
test of time over the last thirty years. I urge you to encourage
the IRS to continue to make improvements in TCMP where such are
appropriate. But I also urge you not to abandon TCMP when no
viable alternative has been suggested, tested and agreed upon by
all of the interested parties who use its results

When I

eved as Commissioner, I was asked repeatedly two
questions by taxpayers, the media, and the Congress: (1) what is
the level of taxpayer compliance with our tax laws, and (2) how
much money are we losing to noncompliance? The ability to provide
credible answers to these two questions, in my opinion, is a key to

taxpayer confidence in our tax system, and that confidence is

ential to the continued viability of our tax system.


APPENDIX IT APPENDIX II
Table II.2: Market Segments and Sample Sizes for IRS’ 1994 TCMP--
Population Sample size
of market Percent
segment Form All that are
Market segment (000) 11208 returns | 1120s
Nonbusiness--no 0 o| 5,042 0.0
schedules
Nonbusiness--no 0 o| 15,175 0.0
Schedules C, E, or F
Nonbusiness with 0 o| 7,958 0.0
Schedule E
Very small business 0 o| 5,105 0.0
Farm business 50 53e| 8,602 6.3
Building trade 144 1,615 5,851 27.6
contractors
All other 116] 2,175] 6,049 36.0
construction
Manufacturing 216 3,662 6,313 58.0
Mining and minerals 25 665 3,457 19.2
Agricultural services 17 444 3,067 14.5
Wholesale trade 213| 4,502] 7,792 57.8
Direct sales to not 0 1,595 o
individual available
Auto and boat dealers 74] 1,369] 3,965 34.5
and service stations
Food and beverage 129 936| 4,931 19.0
Apparel, furniture, 51 917| 3,540 25.9
and general
merchandise
Retail--all other 175, 1,625 4,268 38.1
Real estate 266 2,967 5,759 51.5

Source: Final 1994 TCMP Sample Design.


70

a little like trying to reconfigure a battleship into a
speed boat. It is better to start over. Among the steps
that the IRS should consider are the following

* More frequent (perhaps annual) audits that rely
on far smaller sample sizes and different audit
techniques to facilitate the scoring of returns
and tax gap estimates.

* The emphasis should be on thinking about com-
pliance issues. IRS needs to do compliance
research -- far more than it does today -- but
it needs to design targeted research programs
to test hypotheses and provide data that can be
used in formulating legislative, regulatory and
administrative initiatives.

* Recognize that "compliance" is not the only (or
necessarily most important) issue to address in
designing research programs. Consider, for
example, studying taxpayer compliance burdens
and whether various tax laws are achieving
their stated policy objectives.

* Develop and implement a long-term research
strategy, but place a premium on reasonably
quick responses and flexibility. Most research
efforts should be completed in less than a
year. IRS must accept the fact that projects
on the drawing boards will often be replaced by
new initiatives in response to changing condi-
tions.

. AWord of Caution We believe that the IRS
should not go forward with the 1994 TCMP for two reasons:
GQ) the anticipated benefits do not justify the costs;
and (2) the IRS should revise its research strategies to
meet the current needs of tax administration. But we are
far less confident that the Congress should preclude the
IRS from going forward.

It is certainly appropriate and important for
this Committee to ask hard questions and impose a strict
standard of accountability. However, the final decision
regarding administration of the tax laws generally should
be left to the IRS. In our experience, efforts to
“micromanage" tax administration through specific legis-
lation or the appropriations process often have been
counter-productive. We are not suggesting that Congress
should never intervene in administrative matters; rather
we urge this Committee and the Congress to exercise great
care when deciding whether to take that step


146

DIF is a computer program which compares every line of one’s tax
return with national and regional statistical averages for a person
in a given income bracket and profession. Such averages were
previously ascertained through TCMP audits. If one's return is out
of sync with those tolerances, that return is flagged for a
potential face-to-face audit by a revenue agent.

TCMP data are unreliable simply because they are only as good as
the audits themselves. The reality is the results of IRS audits are
often wrong. For a number of reasons, when IRS examiners report
that citizens have erred in the computation of tax liability, they
have, quite simply, arrived at erroneous conclusions.

In my nearly 20 years of experience dealing with the IRS and
audits, I have seen countless examples of examiner errors. In some
cases, the errors are so basic, one must question whether they were
in fact intentional. Erroneous audit results grow not only from
auditor errors, but from overt acts of tax examiners to bluff and
intimidate citizens into accepting audit results which are clearly
erroneous. These are just a few examples:

1. Where examiners wrongfully claim a citizen has insufficient
proof to support an otherwise legitimate deduction and therefore
the deduction is disallowed.

2. Where examiners wrongfully give an incorrect statement of the
law to a citizen regarding a particular tax deduction or tax
treatment of an item, leading to the disallowance of such item.

3. Where amounts of money transferred from one of the citizen's
bank accounts to another (transactions known as redeposits) are
double and triple counted by examiners, and therefore a citizen is
said to have earned income he did not report on his return.

4. Where tax examiners falsely ciaim that citizens have no, or
limited appeal rights from the decision of tax examiners, and
therefore have no choice but to accept audit results which are
clearly in error.

5, Where tax examiners falsely claim that citizens will suffer
other or greater penalties if they pursue their right of appeal,
and therefore accept audit results which are clearly in error.

6. Where tax examiners explain to citizens that the avenue of
appeal is lengthy, costly, time consuming and the IRS wins its
cases anyway, all the while additional accumulations of interest
and penalties stack up against the citizen.

7. Where, in certain unusual cases but nevertheless prevalent, tax
examiners will claim a citizen can be put into jail if he does not
sign and accept audit results which are clearly wrong.

8. Where, as very commonly happens, tax examiners will threaten
citizens with lien, levy and seizure of bank accounts and property
if they refuse to sign and accept audit results which are clearly
wrong.

9. Probably the single most common reason erroneous audit
assessments are recorded against citizens is most citizens are
simply unaware of their right of appeal. Upon completion of a tax
audit, the IRS mails to the citizen a so-called 30-day letter. The
letter contains the Revenue Agent's Report (RAR) which details the
changes proposed to the citizen's return.

Citizens commonly mistake the RAR for a bill, which it is not. They
do not understand that it is a proposed change to their tax, which


63

measure compliance levels or develop audit selection
formulas until the end of 1998. By this time, the data
will already be 4 years old."? At that point, it should
be noted, we may have a substantially different tax
system.

TT. What we ‘tk Consider
next what we don’t know about TCMP. What is TCMP measur-
ing? What will TCMP teach us? What will we do with what
we learn?

A. What Does TCMP Measure? As the name
implies, TCMP is intended to measure taxpayer compliance.
Proper "compliance" means paying the proper amount of
tax. But far too often that may be an uncertain number
Historically, TCMP has told us the amount of adjustments
proposed by the revenue agents conducting the TCMP au-
dits. “TCMP data has never reflected final determinations
of liability. TCMP measurements therefore turned on a
particular revenue agent's view of the law, the revenue
agent’s conclusions in light of the taxpayer's record-
keeping habits, and ultimately the revenue agent's factu-
al determination when factual matters were in dispute.‘

While there is no reliable data addressing
these issues, IRS sustention rates in other areas are
often less than forty or fifty percent. This raises a
yellow caution flag in taking literally the conclusions
drawn from TCMP data. The IRS has indicated that it will
be able to track the results of 1994 TCMP audits through
any subsequent administrative appeals or litigation
However, it is unclear whether the IRS intends to base
the 1994 TCMP data on the final resolution of these cas-
es.

> GAO/GGD-95-39, at 3.

While erroneous or controversial revenue agent
interpretations of the law confound some TCMP data
record-keeping and "standard of proof" issues are
far more troublesome. For example, taxpayers filing
joint returns, and claiming several dependents, will
be subject to numerous adjustments during a TCMP
audit if they do not produce marriage and birth (or
adoption) certificates, and cannot demonstrate that
they have provided more than one-half the
dependents’ support (as required by Code § 152(a)).
Many of these taxpayers would prevail during the
administrative appeals process or in litigation

Similar situations may arise in many other areas,

2 disallowed deductions or the assertion of
additional earned income based on the agent's deter-
mination regarding "unreasonable compensation";
disallowed deductions and the assertion of addition-
al income based on the agent’s determination that a
company has failed to adequately document expenses
as business-related (rather than personal); in-
creased capital gains tax liability based on the
agent‘s determination that a taxpayer has failed to
establish basis and/or holding periods; worker clas-
sification disputes over employee versus independent
contractor status.



20

developing a backup system specifically for TCMP. IRS had
planned to test these systems in June 1995; but at that time
neither was ready. IRS now hopes to have these tests
completed by August 31, 1995.

-- IRS had planned to have training materials available by
March 1995 and to complete training of the auditors by
September 1995. As of July 12, 1995, the training materials
were not complete. Auditor training is now planned to begin
in October 1995, with most auditors trained by the end of
November 1995.

It 1s important to have a fully functional data collection system
as soon as possible because other steps in the planning process,
such as auditor training and development of TCMP procedures,
depend on it. IRS is counting on TIES to work, but is also
developing a backup system in case TIES fails. TIES has the
capability to do more audit routines better and faster than the
backup system. For example, TIES can automatically produce the
Revenue Agent Report that taxpayers receive on the results of
their audits. TIES also has the capability to perform on-line
data validity and consistency checks, helping ensure that TCMP
data are accurate. The backup system does not have these
capabilities. Therefore, if TIES cannot be used for TCMP, it may
take auditors longer to complete each audit; and TCMP data will
be more prone to error.

IRS officials are confident that TIES will pass the August tests,
but do not have the same level of confidence that TIES can be
used for all TCMP audits. They told us that all revenue agents
who will conduct audits at a taxpayer’s place of business are
scheduled to have portable computers that can handle TIES. These
agents are scheduled to conduct about 57,000 of the 93,000 Form
1040 TCMP audits. The remaining 36,000 Form 1040 audits are
supposed to be done by tax auditors in IRS field offices.
However, all tax auditors do not have access to computers that
can use TIES.

According to IRS officials, only 29 of the 63 district offices
have computers with TIES capability that tax auditors can use.
IRS estimates that about 21,000 TCMP returns will have to be
audited either by having tax auditors use the backup data
collection system or having revenue agents who have adequate
computers conduct the audits. Using the backup data collection
system could delay audits and adversely affect the quality of the
TCMP data. Having revenue agents audit the returns would
increase program costs.‘

‘IRS estimated that having revenue agents conduct the audits
would reduce examination yield by $394 million over fiscal years
1996 through 1998.


37

Mr. ZIMMER, In the hypothetical situation both the husband and
wife are working; do they both have to attend the audit?

Mr. BRAND. No. They would not have to both attend the audit.
They could, depending on what the nature of the situation is, but
one or the other is generally fine.

Mr. ZIMMER. What sorts of questions would they be asked?

Mr. BRAND. Basically we would ask for verification of income. We
would, in fact, go through the tax return on a line-by-line basis in
terms of what was reported so we would want to look at the
W-2s that reflect the information on the tax return in terms of in-
come. We would look at the 1099 forms. We would compare that,
obviously, with the information that we have in the files in those
particular areas. We would ask the question, is there other unre-
ported income? We would look at the dependents.

The depth is up to the individual examiner. As you start the
audit and, in fact, you start through the first 10 lines—and let us
say there are 5 entries on the first 10 lines—you basically begin
to develop a pattern that this is a compliant taxpayer.

Then the examiner has the ability to limit the scope of what they
would accept for proof and what they would basically require the
taxpayer to provide. It is partially judgment, but we do require
them to make an entry, to make a comment on each line item. Be-
cause this is, in fact, a research examination as opposed to an ex-
amination strictly for tax.

Mr. ZIMMER. But, for example, how frequently would a married
couple be asked for a marriage license?

Mr. BRAND. It would depend in many instances, but we would
frequently ask for that. We would ask to prove marital status. One
of the things we would want to prove is that there is a marital de-
duction.

If you have a situation where this was primarily a compliant tax-
payer and all the other items were verified, then the judgment of
the auditor could, in fact, say, I will accept the proof of what I have
got. Part of it is based on oral testimony and other types of proof.

Mr. Zimmer. Are they given a checklist of things to bring with
them, including their marriage license, before they attend?

Mr. BRAND. As we send the letter out, we inform the taxpayer
of the items that are under consideration and since all items are
under consideration, we try to ask people to bring in what we think
is needed for verification. Bring in some type of verification of mar-
ital status.

Mr. ZIMMER. How frequently do they have to come back? For
what percentage of the audits?

Mr. BRAND. Let me provide that for the record. I do not have
that with me, but I will be glad to provide that for the record.

Mr. ZIMMER. Does the IRS ask people in these circumstances ex-
traneous questions such as income from nontaxable municipal
bonds that do not relate to any line-by-line analysis of the tax re-
turn?

Mr. BRAND. We do attempt to get a picture of the taxpayer's fi-
nancial situation and their economic situation. This goes back to
the issue that the chair asked about unreported income, how do
you probe for unreported income? So we are looking for indicators


57

Question 3: If this is not to be done, how will compliance on the specific issues
be measured and matched across the various types of returns?

Answer: It has always been our contention that there are relatively few times that
multiple adjustments will need to be made to a single line item. Until GAO's report, no
other intemal or extemal stakeholders had requested sub-line-item, breakdown of
information. Further contact with GAO revealed that in the cases with an adjustment of
an “other” line item, multiple adjustments were present only three (3) percent of the
time. Since cases where “other” line items are adjusted are, in tum, a subset of the
total sample, the percentage of the cases in the upcoming TCMP where multiple
adjustments would need to be made to an “other’ line item would be expected to be
substantially below three percent.

Comparison of compliance measures across form types does not depend upon
muttiple adjustments per line item. Rather, effective comparison depend upon
consistent treatment and capture of information across form types. Regardless of the
data capture mechanism the Service ultimately uses for TCMP, consistent treatment
and capture of compliance information has been our utmost concern.

Source: IRS
Chief Compliance Officer
September 14, 1995


APPENDIX T APPENDIX I
GAQ REPORTS THAT USED TCMP DATA

Erroneous Dependent and Filing Status Claims (GAO/GGD-93-60, Mar.

19, 1993)

We found that the dependent support test was too complex and
burdensome for many taxpayers to voluntarily comply with; about 73
Percent of dependent claims failed to meet the dependent support
test. We recommended that Congress consider enacting legislation
that would substitute a residency test for the support test and
consider eliminating the household maintenance test from the
head-of-household filing status. We recommended that IRS correct
the problems in its limited matching program and implement a 100-
Percent computer matching program to identify erroneous dependent
Claims. We used a sample of 1988 TCMP cases to determine the
sources of erroneous dependent and filing status claims.

8
Carryover (GAQ/GGD-93-131, Sept. 23, 1993)

We found that IRS instructions on the amounts that corporations
should report on the net operating loss deduction line were
incomplete and confusing. We also found that it was profitable to
audit NOLD returns. We recommended that IRS revise its
instructions on reporting the deduction to clarify amounts that can
be deducted, clearly define net operating loss carryover, require
corporations to annually report their carryovers, and use the
reported amounts to track corporate deductions of these losses. IRS
has implemented our recommendations. We used the 1987 corporate
TCMP to identify taxpayers who claimed the NOLD incorrectly.

(GAO/GGD-93-133, August 13, 1993)

Small business tax noncompliance is a serious problem. TCMP audits
showed that small corporations in 1987 and sole proprietors in 1988
overstated their deductions by an estimated $40 billion and did not
file required information returns on at least $19 billion in
payments to individual taxpayers. Our analysis of TCMP databases
showed reverse matching could have identified overstated deductions
and unreported wages. We recommended that IRS do a limited test of
a reverse matching program on wages while it addresses the
limitations to an expanded program for other deductions, such as
for services and bad debts.


144

Members of the House Ways and Means
Oversight Subcommittee

August 1, 1995

One subject of potential concer to us, as practitioners and tax representatives, is the role of
“economic reality” or “financial status” questions to be used in the forthcoming round of TCMP
audits, We have been in oral and written discussion with the IRS National Office about the potential
conflict between information needed for an audit of a tax return and taxpayers’ rights of privacy.

Questions involving “financial status” that extend outside the four comers of the tax return are
appropriate only when an examining agent has reason to believe that there may be unreported income
onareturn. In the absence of such belief or suspicion, we believe it appropriate to challenge when
this line of questioning turns from being an audit tool to an improper invasion of taxpayer privacy

We acknowledge the IRS’s need to probe for unreported income, but would urge that taxpayers not
have to respond to questions that have at best only a tangential connection to that subject.

If you have any questions or wish to discuss the contents of this letter, please do not hesitate to
contact one of the following

Joseph Cammarata
Tax Practice and Procedures Committee Chair
(703) 352-3850

-or-
Anita L. Horn
AICPA Technical Manager
(202) 434-9231
Sincerely,

btrl li

Deborah Walker
Chair
Tax Executive Committee

DW/ALH/kvk

cc: Joseph Cammarata, Tax Practice and Procedures Committee Chair
Jeffrey L. Raymon, Financial Status Audit Working Group Chair


90

STATEMENT OF JOSEPH F. LANE, ENROLLED AGENT, ON
BEHALF OF THE NATIONAL ASSOCIATION OF ENROLLED
AGENTS

Mr. LANE. Mr. Chairman, my name is Joseph Lane and I am an
enrolled agent in private practice in Menlo Park, Calif.

Thank you for inviting me to testify here today on behalf of the
National Association of Enrolled Agents. We have a written state-
ment which we have submitted and I assume it will be in the
record. A lot of information has been given already about the his-
torical basis for TCMP, and I will not bother Boing over that again.

I will go over another taxpayer’s reaction to the TCMP which
was a little different than Ms. Smmith’s here today. I had a medical
doctor who was a client who went through the last TCMP in 1988.
His definition of the process was “an autopsy without benefit of
dying.” He had his personal income tax returns, his corporate in-
come tax returns, his pension plan returns, and the returns of his
children’s trust all examined as part of the TCMP.

He was still amazed about the sheer volume of data that the
auditor required and the cost of having representation through the
process well exceeded his annual costs. The result of his audit was
that all the returns were accepted as filed, but that is scant solace
for his lost income for the time away from his practice, the months
of responding to ever-increasing demands for more and different in-
formation, the stress of being subjected to an IRS probe into all of
his financial affairs, and the necessity of having to explain many
nontax related transactions to the satisfaction of the examining
agent. That last point was particularly vexing to him.

He questioned why he had to explain to the examiner why he re-
financed his ski house. He had never deducted any portion of the
ski house for his business. It was for the sole use and enjoyment
of his family and he felt that it was none of the agent’s business.

My explanation that the agent had to account for all deposits
into his bank accounts during the period under examination to en-
sure all income was properly reported merely served to further en-
rage him that his honesty should be questioned about reporting his
business income.

When I recently told him the IRS would be conducting another
TCMP this fall his reaction was, in the words of the old Irish bal-
lad, “in the language that the clergy does not know.”

I think basically what you have at issue today, is should we con-
duct TCMPs the way they have been done for the last 30 years or
is there a better way? IRS has made a big point over the last 4
or 5 years of reinventing the IRS, and they have reevaluated a lot
of the processes they have used over the years and they have modi-
fied a substantial number of them.

Our argument is that it might be time to take a look at a dif-
ferent way of looking at this data. There is a cultural change un-
derway within the Service. They have begun to reemphasize tradi-
tional methods of auditing with their recent training programs, fo-
cusing on economic reality, and they have begun to question the in-
come more than the deductions on tax returns.

While there are legitimate concerns that have been voiced about
the wholesale implementation of this economic reality program, you
can hardly fault tax administrators for trying to find undisclosed


44

I thank you all for being here this morning to bring us up to
speed on TCMP. I have a number of questions that were really
echoed by some of my colleagues already, but I wanted to focus a
little more on them.

The two concerns I have are taxpayer burden and the cost of the
program. I do not question the value of the previous TCMPs. I won-
der if this one is overbroad, whether it is timely, and whether there
are ways to make it more efficient.

In terms of the cost to the government, I have heard various
numbers this morning and there are various numbers in the testi-
mony that I have looked at. I have seen anywhere from $200 to
$500-plus million. I guess all I can say is unless someone has some
comment on that that gives us a more precise number, that is sort
of the range that I would be thinking, $200 to $500 million in cost
to the IRS to conduct this.

Mr. BRAND. Mr. Portman, I think there are a number of ways to
look at cost. The fact is that we will have the employees on board
and we will be paying the salaries of the employees, whether they
are involved in TCMP examinations or other examination work. So
to basically look at the staff years, FTEs and moneys applied, there
is one way to estimate it.

The way that I prefer to estimate it is the opportunity cost that
is lost. We know by working TCMP examinations that we will suf-
fer a decline in the amount of penalty and interest or the amount.
of tax and penalties that are recommended, because this is a ran-
dom sample, and by its very nature, a no change rate is high.

I believe a correct way of estimating cost is to look at revenue
projections had we not done the TCMP and applied these FTEs in
that manner. My recollection is that that is about $1.5 billion that
we would have received from these particular resources. We know
the results. We estimate the results of the TCMP to be about half
that, so your opportunity costs are really in terms of revenue over
the life of this. The cost of the employees, and so forth, are ex-
pended by the ——

Mr. PoRTMAN. Let us focus a little more on that, if we can. I was
not planning to get into this area, but you raise an interestin;
question and that is what the projected savings are over time real-
ly to the system through increased compliance and what are the
opportunity costs that would be missed without doing this.

We are talking seriously in this subcommittee and it is a na-
tional debate now about fundamental change in the tax system. We
are talking about a flat tax, we are talking about a consumption
tax. There are various proposals, but all of them are, in essence,
replacing the current system with a new one, a radical overhaul of
our existing system.

I would think that the TCMP results might well not be generat-
ing that kind of savings over time, if indeed we go ahead with this.
I think the projections are based on our current system, which I
think is unlikely to survive at least past 1997. I think to go ahead
with such a massive undertaking of 153,000 individuals and all of
the time and effort that the IRS is going to put into this, where
otherwise IRS would be focused on making the current. system
work better over the short term, is questionable, given where we
are in terms of major tax reform.


85

On the other hand, if there is any doubt at all that major tax
changes are coming, if there is a possibility that the tax system re-
mains much as it is for a few more years, then TCMP is urgent.
It has not been done since 1988. It is long overdue. It was canceled
in 1991, I understand, because of a variety of internal and external
objections to it, the normal objections that come any time any regu-
latory agency does a random inspection of any kind.

All such inspections are intrusive by their nature. Regulatory
agencies depend on them absolutely. The fundamental issue here
is should regulatory agencies be required to compensate individuals
for that necessary intrusion, and should random basis be permitted
as a basis of selection.

Mr. GOLDBERG. Mr. Hancock, as the unnamed Commissioner who
was responsible for that heinous act in 1991, I would like to com-
ment, since I was the one responsible for the decision to allegedly
cancel the TCMP.

Once again, I believe that random selection of individuals and
enterprise for a thorough examination is a necessary component.of
the tax system. You have ge to do it, if you are going to get the
right answers. So I do not dispute that point.

it was not a question of canceling TCMP, shoving our heads in
the sand and making light know-nothings. It was saying you can
redesign the system, late 20th century statistical techniques, sam-
pling techniques, research techniques, saying that we can do a bet-
ter job of getting done what we need to get done at the IRS, and
it was not a question of doing nothing.

It was saying go rethink the system, come up with a better de-
sign and get it done. I believe the suggestions again of Dr.
Scheuren and others who have said far smaller, far more frequent
TCMP-like examinations will be less intrusive at the end of the day
and provide the government with far more reliable and far more
useful information. This program, by its own design, is not goin;
to be materially finished until 1998. If the Congress goes forwai
with tax reform in 1997, it is a day late and a dollar short.

To the extent, for example, the chairman suggests, issues of cash
economy and the underground economy are relevant and that
maybe some type of national sales tax or some other low rate of
tax would improve compliance, those are important questions. You
can only answer those questions through well-designed research
programs. Those research programs will necessarily entail as a
component some random selection of taxpayer for examination.

But it is not a one-shot 153,000 returns that you are going to do
starting for tax year 1994. They are going to be done in 1999, at
which point somebody is going to say are we going to do another
TCMP, and we are going to say, well, we do not have anything bet-
ter, we do not know what to do yet, we are dealing with a different
system now, we had better do a TCMP, and I suggest that more
annual, more focused, far smaller efforts at the end of the day are
a better use of the taxpayer’s dollar, and by definition less intru-
sive.

Mr. Gupps. Mr. Hancock, I would like to respond to this one. For
30 years, we have measured taxpayer noncompliance and compli-
ance in this country and we have estimated the tax gap based on
a methodology. That methodology is TCMP. It has grown, it has


62

Congress in 1993. It also represents more than 25% of
what the IRS will probably spend on Tax Systems Modern-
ization over the next three years. It is more than three
times greater than the 3-year budgets for both the IRS
Statistics of Income and Research Division functions

B. Burden on Taxpayers Beginning in
October of this year, more than 150,000 individuals,
families and small businesses will be subject to TCMP
audits. While there are no reliable estimates of the
time that these taxpayers will spend or their out-of-
pocket costs, no one doubts that TCMP audits are intru-
sive, burdensome, and expensive. Taxpayers must justify
-- to the satisfaction of IRS agents -- every item on
every line of their 1994 returns. If you claimed the
right to file a joint return, you have to show the agent
your marriage certificate. If you claimed dependents

you better have birth certificates available for the
agent. Forget about simply reconciling reported income
by matching W-2's and 1099’s. You must explain every
bank deposit and every investment to show that you had no
unreported income. If it appears to the IRS agent that
you are living beyond your means, there will be more
explaining to do. Your "word" and some reconstructed
notes will be worth little; contemporaneous documents and
the affidavits of third parties are often required.

More than 60,000 1994 TCMP audits will involve
business enterprises (corporations and partnerships), and
most individual TCMP audits will involve taxpayers with
complex returns. In the absence of any hard data, it
seems reasonable to speculate that out-of-pocket costs
{including employee and preparer time) will be in the
range of $5,000 to $10,000, and that the average individ-
ual will spend at least 20 hours preparing for and deal-
ing with a TCMP audit. On this basis, the 1994 TCMP
would impose between 750 million and 1.5 billion dollars
in unreimbursed, private out-of-pocket costs on American
citizens, and consume more than three million hours of
their time. Coupled with the IRS‘s costs, the 1994 TCMP
is an undertaking that will cost more than one billion
dollars and could well cost several billion dollars.’

What do we learn from imposing this burden?
For the moment, consider these results from the 1988
TOMP: (a) more than 50 percent of those audited owed no
additional tax; (b) about 7.5 percent of those audited
were entitled to refunds, averaging $284; and (c) the
average proposed adjustment for the 40 percent regarded
by the agents as owing additional tax was $780.

. Time To Completion The IRS expects
to complete the 1994 TCMP by the end of 1998. The Decem.
ber 1994 GAO report expressed doubt that the IRS would
start as scheduled, and concluded that: "Even with this
start date, the TCMP results cannot be used to fully

2 In light of stated concerns over the burden imposed
by TCMP, and the IRS’ stated objective of reducing
taxpayer compliance costs, it is somewhat surprising
that the IRS does not plan to gather data on the
time and money that taxpayers spend on TCMP audits
(much less, gather data on compliance burdens faced
by taxpayers in filing their original returns) .


86

changed, it has evolved over that 30-year period. I believe gen-
erally, as a methodology for those two purposes, it is accepted by
the American public. They understand it and they accept the re-
sults.

Now, there are a lot of criticisms that you can raise, and here
is my point. My point is, if you are going to postpone it, then before
you start saying what we are going to do, we should come up with
an alternative. Let us get the alternative and be sure that we have
the buy-in from the various constituencies out there that this is

‘oing to be as good as or better than what it is that we are aban-
loning.

I think your tie between tax reform that is going to be discussed
and this program is an interesting one, because, in effect, what I
am suggesting is that we should do the very thing that I applaud
the Congress for doing at the present time. We are going to be dis-
cussing what the alternative tax systems are. We have proposals
up on the table. People are going to know what they are, and then
we will see in the final analysis, whether the country agrees to
abandon what we have and go to something else or modify it in
some way.

If I could answer that, I guess I could answer your question with
respect to the cost benefit of the current TCMP. I would make just
a practical suggestion to you. I would suggest to you that as we go
about talking about something that is going to be far more complex
than TCMP, namely a potentially alternative tax system, if we get
an awful lot of things held up, not right now, but since 1991, and
you put those chips on the table, you are putting an awful lot of
pressure on yourselves and on the system in terms of making what
seems to me to be a more important choice.

Some have said if you want to drive tax reform, let the TCMP
go forward. With all the media publicity and the wailing over the
153,000 taxpayers, maybe that will drive tax reform. My reaction
is I would do it for another reason. I would let the system go for-
ward until we make the conscious decision in this country to
change it. That would be my response.

Mr. HANCocK. Mr. Gibbs, I agree that the principle of the TCMP
has probably operated for about 30 years. Thirty years ago, we did
not have anything close to the gray areas that we have got now in
compliance. When you read in Money Magazine that 50 account-
ants came up with 50 different conclusions and nobody got it right,
you have got a real problem of compliance with the law. Even peo-
ple who want to comply with it have a problem. What do you do,
say I will not take the gray area? Well, you are nuts if you do not
take the gray area. Frankly, I think that there are a lot of changes
to be made in the internal revenue law without having to com-
pletely redo it. However, I am in favor of getting rid of it com-
pletely.

Mr. Gipss. I would simply comment to you that 30 years ago I
think this same discussion was held and that was the reason they
came up with TCMP. It does give us good data about what we do
know. Maybe there are other methods that we should use for
things we do not know. But I would not abandon the method for
measuring what we do know simply because it is not fulfilling all


121

In response in part to suggestions from Congress and the
academic community, the current TCMP survey has added specific
questions designed to help identify trouble-spots where complexity
is the primary source of audit adjustments, along with very
detailed issue coding to pinpoint specific sections of the tax law
where this occurs. More attention needs to be focused upon
pretesting this part of the survey, the selection of categories,
and the proper training and instruction of the auditors. Although
I thus have some reservations about aspects of TCMP's planned
implementation, the potential of identifying problem laws and
measuring their compliance costs could be enormous. Armed with
detailed information about the true costs of complexity, Congress,
tax professionals, and’ the IRS could mount genuine reform. With
the better understanding of the actual costs of compliance,
Congress could confront and debate these issues before it passes
new tax legislation.

Second, TCMP could also play a vital role in identifying
correctable administrative failures which make taxpayers‘ lives
difficult. TCMP provides a unique window on IRS auditor behavior.
There is a variety of evidence suggesting that there are gross
inconsistencies in how individual auditors, Service Center
personnel and collection officers treat taxpayers. Data analyses
at my center have repeatedly shown enormous and inexplicable
variation in audit and collection practices from one district to
the next.5 Internal IRS studies, backed by GAO reports, have
discovered that inappropriate advice and collection claims occur
all too often. When contested, initial IRS auditor findings are
frequently abandoned. A recent GAO study, for example, showed
that only 22 percent of taxes recommended by IRS's audits under
the Coordinated Examination Program between fiscal years 1983 and
1991 were eventually collected after any appeals or litigation.®
My analyses using TCMP data matched with IRS Master File records
showed significant differences between TCMP noncompliance
estimates and final assessments after a taxpayer appeal.7 Studies
by other tax authorities have found striking inconsistencies in
auditor judgments on the same return.

Role of Legal Complexity in Shaping Taxpayer Compliance," in van
Koppen, Hessing, and Van Den Heuvel (eds.), Lawyers on Psychology
and Psychologists on Law. Amsterdam: Swets & Seitlinger (1988),
Susan B. Long and Judyth A. Swingen, “An Approach to the
Measurement of Tax Law Complexity," Journal of the American
Taxation Association, Spring 1988.

5 See, for example, David Burnham, A Law unto Itself: Power,
iti . New York: Random House (1990, Appendix,
pp. 377-395).

6 : sng con: .

Tax-Related Work, GAO/GGD-95-66 (February 1995), p. 44. See also
GAO/GGD-94-70; Susan B. Long and David Burnham, "Solving The
Nation's Budget Deficit With A Bigger, Tougher IRS: What Are The
Realities?" Tax Notes, August 6, 1990, pp. 741-757.

7 susan B. Long and Judyth A. Swingen, "Taxpayer Compliance:
Setting New Agendas for Research," Law and Society Review, volume
25, number 3 (1991), pp. 658-660.

8 see, for example, Henk Elffers, Income Tax Evasion: Theory and
Measurement. Denventer: Kluwer (1991); Henk Elffers, Henry S. J.
Robben, and Dick J. Hessing, "Under-Reporting Income: Who Ta the
Best Judge--Taxpayer or Tax Inspector?" 154 Journal of the Roval
Statistical Society (1991 Ser. A), Pare 1 125; Henk Elffers,
Henry S. J. Robben, and Dick J. Hessing, "Reliability and validity
of Tax Audits: Can We Have Confidence in the Opinion of the Dutch
IRS on Noncompliance?" Working Paper, Erasmus Centre for


124

collects, on average, well more than $5,000 on each audit. Those
numbers are useful in saying something about what the costs of
the TCMP are in terms of the opportunity costs to examiners.
Every time a TCMP audit is done, at least $4,000 is given up be-
cause some more productive audit could have been done.

So, for example, if 50,000 households are selected for TCMP
audit, that would be approximately $200 million given up of Fed-
eral revenues to do those TCMP audits.

IRS audit programs not only generate direct audit assessments
but also generate additional indirect revenues to the deterrent ef-
fect they exert on potential cheaters. Although indirect audit reve-
nues are difficult to measure, most experts agree that they are sub-
stantially larger than direct assessments.

Now, in my view, a considerable body of evidence indicates that
TCMP is critical for the design and implementation of IRS audit
selection guidelines. One of the most important uses of TCMP is in
the development of DIF. During the past 3 years, Brian Erard, who
is at Carlton University, andi have investigated IRS audit pro-
grams in the Oregon district in considerable detail. Our analysis is
based on a large data set we have assembled and includes most. of
IRS audits of Oregon households for tax year 1987.

What we find when we look at the data is that nearly one-half
of all IRS audits are based on DIF. Further, we find that these DIF
audits generate significantly larger assessments, on average, than
are generated by the remaining non-DIF audits. These findings, I
think, strongly suggest that DIF and, hence, TCMP is, in indeed,
a critical factor in audit selection.

I wanted to remark parenthetically, by the way, that Brian has
also helped the IRS on a recent study of nonfilers, an issue that
came up earlier today. I just wanted the subcommittee to know
that there has been a recent study of nonfilers which you might
want to take a look at, although, in fact, nonfilers are a pretty
small amount of the total noncompliance tax gap that we have in
the country.

TCMP is also useful in helping IRS researchers discover patterns
of noncompliance that have been overlooked by existing audit pro-
grams. A good example of this is the discovery a few years ago,
based on an analysis of TCMP data, of the fictitious dependents
problem which has already been discussed today, so I will not talk
about it further.

What are the main alternatives to TCMP? I think probably the
clearest alternative would be to rely on ordinary audit data instead
of TCMP data to come up with audit selection guidelines. In fact,
ordinary audit data is not an adequate substitute for TCMP data.
TCMP is a random sample and provides an accurate picture of the
entire taxpayer population. Ordinary audit data does not and we
could talk about that further if we need to, but I have worked with
both kinds of data and see some clear differences between them.

A second alternative would be survey data. Unfortunately, sur-
vey data is extremely unreliable in this area. The third alternative
would be to abandon statistical analyses and instead rely on exam-
iner expert judgments. I did want to note that currently the exam-
iner judgments are used in combination with DIF very effectively,
but I do not think that they could serve as an adequate substitute


31

APPENDIX II APPENDIX II
rke me}
Market Sample size
segment Percent
population | Form | all that are
Market segment (000) 1065s_| returns _| 10658
Nonbusiness--no ) Cc) 5,042 0.0
Schedules
Nonbusiness--no 0
Schedules C, E, or F o| 15,175 0.0
Nonbusiness with 0 0 7,958
Schedule E
Very small business 0 0 5,105 0.0
Farm business 104 621 8,602
Building trade an 503 5,851 8.6
contractors
All other 25 521 6,049 8.6
construction
Manufacturing 24 554 6,313 8.8
Mining and minerals 39 693 3,457 20.0
Agricultural services 21 521 3,067 17.0
Wholesale trade 18 528 7,792 6.8
Direct sales to 1 89 1,595 5.6
individual
Auto and boat dealers 16 496 3,965 12.5
and service stations
Food _and beverage 56 557 4,931 11,3
Apparel, furniture,
and general 23 521 3,540 14.7
merchandise
Retail--all other 56 524 4,268 12.3
Real estate 662 692 5,759 12.0

Source: Final 1994 TCMP Sample Design.


7

dition, States use relevant portions of our data files for studies of
compliance with their income tax laws.

In conclusion, our goal is to improve our detection of noncompli-
ance, to more effectively assign our resources to the areas with the
highest noncompliance, and to identify compliance problems which
can be corrected through legislative change. To achieve this goal,
the IRS needs data that is statistically valid within market seg-
ments and on a geographical basis. The best method we have iden-
tified to date for securing this data is TCMP.

The IRS is on target to implement the upcoming survey on time.
I assure you we will meet the challenges of conducting the exami-
nations in a timely manner and with the least possible burden to
taxpayers.

Madam Chairman, this concludes my prepared remarks. I will be
happy to answer any questions you or the other members may

ave.

[The prepared statement follows:]


189

WRITTEN STATEMENT OF ERIC J. TODER
DEPUTY ASSISTANT SECRETARY (TAX ANALYSIS)
DEPARTMENT OF THE TREASURY
SUBMITTED TO THE WAYS AND MEANS OVERSIGHT SUBCOMMITTEE
IN CONNECTION WITH HEARING ON IRS’S TAXPAYER COMPLIANCE
MEASUREMENT PROGRAM
JULY 18, 1995

Dear Madame Chairman and Members of the Subcommittee:

Tam happy to submit this statement at your request regarding the ways in which
Treasury's Office of Tax Policy (OTP) relies on the data compiled in the Internal Revenue
Service's (IRS’s) Taxpayer Compliance Measurement Program (TCMP) audits. The
principal purpose of the TCMP audits is to develop information that will enable the IRS to
administer the tax laws more effectively. IRS is solely responsible for the timing, scope,
and design of the TCMP audits. But the information the audits produce is also helpful to
OTP for both policy analysis and revenue estimation.

From a policy perspective, TCMP audits provide OTP with valuable information on
those aspects of the Federal tax system that create the greatest problems of compliance for
taxpayers and administrative problems for the IRS. TCMP audits indicate which items of
income, expense, deduction, or credit generate the greatest numbers of errors per response.
Such errors can occur either because the specific tax provisions associated with those items
are unduly complex and confusing for taxpayers, because they are difficult for the IRS to
verify, or both. The TCMP data can thus be very helpful to OTP in suggesting policy
changes that reduce taxpayer burden and improve compliance. From an estimating
perspective, TCMP audits provide useful information on how proposed changes in
information reporting or in the level of resources devoted to tax administration would affect
future tax receipts.

Treasury's Office of Tax Analysis (OTA) evaluates numerous proposals to improve
taxpayer compliance and the ability of IRS to enforce the tax laws. In estimating the revenue
impact of these proposals, it is first necessary to establish a "baseline" of the level of non-
compliance. The TCMP is the only source of data that provides sufficiently detailed
information on the level of compliance associated with specific tax provisions. For example,
the Energy Act of 1992 required buyers who deduct seller-financed mortgage interest to
report the name and social security number of the seller. ‘The revenue estimate for this
proposal required two key pieces of information: (1) the degree of non-compliance in
reporting home mortgage interest deductions associated with seller-financed mortgages and
(2) the extent to which the IRS could expect to close this gap by requiring the additional
information. TCMP data on the level of non-compliance for seller-financed mortgages and
on the level of compliance for mortgages financed through financial institutions that currently
required information reporting were used to estimate the revenue gain from the proposed
increase in reporting requirements.

Another example of the use of the TCMP data in estimating the revenue effect of tax
compliance initiatives is the provision of the Omnibus Budget Reconciliation Act of 1993
which required donors to obtain substantiation from donee organizations for charitable
contributions of $250 or more. The provision required a charitable organization to state the


147

they can appeal. But with lack of understanding of the appeal right
or process, and lack of funds to hire a professional, many
nothing. This leads to the issuance of a notice of deficiency,
which requires the filing of a petition in the Tax Court within 90
days. If the petition is not filed, the amount of tax claimed
becomes assessed without further action necessary on the part of
the IRS. In effect, the citizen loses his tax audit case by
default.

This is certainly not an exhaustive list of the things that
commonly happen to honest, perfectly law abiding citizens during
the course of routine face-to-face examinations, such as a TCMP
audit. They are, however, a few of the more common examples of what
takes place on a daily basis within the realm of tax law
administration.

Another very compelling reason why tax audits are often wrong is
the fact that tax auditors are poorly trained in the law. We have a
tax law that consists of 17,000 pages of law and regulation which
was changed more than 100 times just during the decade of the 1980s
alone, The pure size, scope and evolution of the law makes it
physically impossible for any human to understand its full scope
and application.

This problem is particularly troublesome in multi-year audits,
which are becoming more and more common. A multi-year audit
involves more than one tax year. The IRS may, for example, attempt
to examine each of the three open years on one sitting. In fact, in
the current TCMP model, IRS will provide its agents with three tax
returns for the each TCMP subject. They will be, the return for the
primary year, and returns for the two previous years.

Problems arise in such audits when the law treats a given
transaction differently in one year than it does in the next. very
commonly, an examiner will treat the transaction the same for all
years in question. This makes the resulting examination report
correct as to one year, but incorrect as to the next. This despite
the fact the it reads identically for both years.

The fact that IRS examiners are poorly trained yet are under
pressure to produce results is confirmed by a recent General
Accounting Office (GAO) report. In testimony to this subcommittee,
Lynda D. Willis, associate director of tax policy at GAO described
many problems businesses face in complying with the tax laws. Her
testimony described the results of a survey GAO conducted to
determine the compliance burden faced by small businesses. See: Tax
System Burden, Tax Compliance Burden Faced by Business Taxpayers,
GAO/T-GGD-95-42, December 9, 1994.

Among other things, Ms. Willis said:

"The complexity of the code has a direct
impact on IRS' ability to administer the code.
The volume and complexity of information in
the code make if difficult for IRS to ensure
that its tax auditors are knowledgeable about
the tax code and that their knowledge is
current. Some business officials and tax
expects said that IRS auditors lack sufficient
knowledge about federal tax requirements, and
in their opinion this deficiency has caused
IRS audits to take more time than they
otherwise might.* * *" Ibid, page 3.

The audits not only take more time, leading to more cost for both
the agency and the private sector, but they often result in


153

expenses, no amount of enforcement programs or compliance
initiatives will ever solve the problem. Congress must simply face
the fact that it is spending too much of our money.

At the same time, we must pursue a course of radical tax reform. As
evidenced by the GAO reports cited in this testimony, our system
cannot possibly continue to operate under the status quo. The IRS,
in its opinion, will never have enough information to enforce the
law. It will never have enough money, manpower or equipment to
administer ‘the law. Yet we cannot, it seems clear, continue to
allow the agency to grow in size, power and sweep, given its
deplorable record of unaccountability on matters so basic as its
own financial affairs.

Ultimately, to solve our nation's tax problems, we must abandon the
IRS and the income tax system altogether. We must move to a system
which is not dependent upon knowing the intimate details of every
citizens’ private life in order to collect the revenue needed to
fund the government. We must move to a system which does not
require 120,000 IRS employees and a budget of $8.2 billion to
administer. We must adopt a system which frees us of the
requirements to file 210 million tax returns and 1.3 billion
information returns annually. We must develop a system under which
the American people will no longer have to chose between paying
their taxes and feeding their families.

It is my considered opinion that only a national retail sales tax
can accomplish all those things. I believe time has come for
Congress to stop discussing bandaide treatments for a hemorrhaging
patient.

Thank you.

O


46

153,000 people in this focus group, so I would think there might
be a way to just make it work better, work more efficiently.

Finally, I would say that I think any time we get into these
kinds of audits—and I know this is only 153,000 Americans and
the benefits could potentially accrue to millions of Americans in
terms of less audits in the future—I think we have to look carefully
at who is doing these audits, whose word is taken.

You said earlier there will be a lot of discretion with the auditor.
Who are these auditors? Are these the junior auditors who often go
out on these audits to cut their teeth? Are these people who are
going to have some experience, some background?

I think we need to be very careful about doing this, if we are
going to do what I perceive to be perhaps an overly broad ap-
proach, to do it in a way that gives the taxpayer the ability to have
an appeal process or to come back with information that, although
it might not be all the documentation lined up as the IRS agent
would like, it is something that the IRS can accept and then move

mn.

Mr. BRAND. One of the things we have done this year to increase
quality and to speed up the process is that we have required spe-
cific levels of experience before an auditor can be assigned to a
TCMP audit. That level of experience obviously will vary dependent
on the complexity of the tax return.

Just one other point, too, in terms of the size of the sample.
What the TCMP gives us that we have never had before, with the
construct of this TCMP, are really two very important items that
we have not had before, from a tax compliance standpoint. The first
is for the first time in our history we will have compliance rates
by 30 geographical areas across the United States which are analo-
gous to our district operations. We will be able to determine what.
the compliance rate is within a much tighter geographical area.

Before, everything we did was national in its estimation and na-
tional in its scope. We know from the prototype work that we have
done, that there is substantial difference in compliance in various
geographic areas, and so that helps us allocate resources.

The second item is that this will give us compliance by market
segment. In the past, someone could be involved in retail, either at
the corporate level or the individual level or subchapter S, and that
all got buried more or less in the same type of situation. What we
believe now is that there are different compliance levels, depending
on the market segment, whether it is retail, wholesale, mining, or
manufacturing. Again, the purpose of the expanded examinations
is to give us compliance rates that are both geographically sensitive
and also by market segment.

Mr. PorTMAN. I thank you for that.

One final question and then a comment. Has there been thought
given to compensating individuals who go through this process,
who expend these hours that we will be learning about from the
information Mr. Brand is going to provide us? I would think the
subcommittee could also benefit from some analysis of what the
cost might be to the taxpayer, given the realities. If you are looking
to people who have business income, I think it is going to require
professional assistance and there will be tremendous cost to that.


6

Through analysis of TCMP data by market segment and geo-
graphical area, the IRS will use education, outreach, and focused
enforcement activities in a way that maximizes our impact. In ad-
dition, the data will provide better information on noncompliance
that can be corrected through legislation.

The 153,000 sample size represents a filing population of over
123.9 million returns—only about one-tenth of 1 percent of that
total filing population. Most of the examination work will occur in
fiscal years 1996 and 1997. Thus, we estimate that approximately
23.5 percent of our total revenue agent and tax auditor staffing will
be devoted to TCMP examinations. In fiscal year 1997, this will de-
crease to 16.4 percent with a further decline in fiscal year 1998 to
7 percent of the total revenue agent and tax auditor staffing.

Although this TCMP survey does require a fair amount of exam-
ination resources, the GAO has stated that the concern that TCMP
is too costly has little merit. The most effective allocation of en-
forcement resources and additional recommended tax law changes
that data from TCMP will provide should generate millions more
in revenue than the cost of the TCMP survey.

TCMP audits carefully review all aspects of the tax return and
the extent to which it reflects the taxpayer’s true tax situation.
However, our examiners do have flexibility as to the depth that
this review must take and small dollar amounts are not assessed.
Thus, we balance the need for accurate data with the burden this
places on the taxpayer.

The IRS has considered alternative ways to capture the data that
we need to administer the system, including gathering enforcement
data from operational programs, conducting numerous specific
studies, and conducting opinion surveys. While these alternatives
would provide some measure of compliance, there are a number of
shortcomings to such data.

The alternatives we have investigated and tried have not proven
up to the task of supporting accurate, verifiable compliance meas-
ures. The IRS uses TCMP data to develop DIF formulas to identify
and select returns for examination that have the highest potential
for tax change, to identify emerging noncompliance trends, to iden-
tify compliance problems which can be corrected through legislative
change, to assign resources to areas with the highest noncompli-
ance, and to develop tax gap estimates.

Earlier in my testimony, I shared with this subcommittee the im-
pact that TCMP has had on reducing returns that are examined
and result in no change to the reported tax liability. In my written
testimony I discuss three examples of how TCMP results have un-
covered compliance problems which were addressed through legis-
lative change. These examples involved a problem with the number
of dependents being claimed, the overstating of child care credits,
and taxpayers not fully reporting their State tax refunds. In all
three examples, the legislative changes resulted in substantial ad-
ditional tax revenues.

TCMP data is also used by other agencies and the executive and
legislative branches of government to adjust national income and
products accounts, and to estimate potential revenue gains from
tax proposals intended or expected to affect noncompliance. In ad-


40

Mr. LAUGHLIN. Yes, sir.

Mr. Branp. Alimony income was going unreported. That is a
$316 million gain in revenue as a result of requiring information
reporting in that area. There were also excessive exemptions for

ople claiming the additional exemption for being 65 or older.
oh ld care credit was going unreported and being overreported in
one instance, and being underreported by the providers of child
care. There are a number of examples like that that show billions
of dollars of additional revenue.

Mr. LAUGHLIN. You anticipate by doing another TCMP audit that
you will uncover other areas where legislation will bring forward
additional revenues?

Mr. BRAND. I think the thing to realize about the TCMP is that
the primary purpose is to improve the selection process for tax re-
turns. There is the ancillary benefit that we sometimes walk in and
find these particular trends. Oftentimes, we confirm the trends sta-
tistically that we believe are occurring through our normal exam-
ination program, but it provides statistical validity to the problem.

Mr. LAUGHLIN. Ms. Stathis, I have one other area of inquiry and
that is that you have stated that the IRS could speed up its analy-
sis of the TCMP data. Did that also include a discovery that the
IRS could speed up the time the taxpayer spends going through the
audit, and if you could give us some examples of specific rec-
ommendations you had in mind when you said they could speed up
their analysis?

Mr. Biock. I would like to answer that question. IRS is doing
a couple of things in this TCMP audit that should reduce the
amount of time auditors have to spend with taxpayers. Before the
audit begins, each auditor will be supplied with 3 years’ worth of
taxpayer information. They will have information return data on
taxpayers and a number of other types of taxpayer related informa-
tion. With this information, the auditors should be able to plan
their audits and know exactly what questions they will have for
taxpayers.

When they visit taxpayers, they should not have to burden them
for copies of data they, the auditors, already have. For example, if
the auditor already has a W-2, there is no need to ask the tax-
payer for the same W-2.

‘e believe IRS will be able to use the data faster under this
TCMP because it will all be entered electronically by auditors. Al-
though IRS will not be able to update its audit selection formulas
until all of the data is in, IRS can still use the data as it is being
entered to look at trends in noncompliance b geographical area.
This should help IRS see some potential problems long before the
data from all TCMP cases is analyzed, and it then could start to
work on those problems.

That is how we believe IRS should be able to reduce taxpayer
burden and speed up use of the data. We do not know for certain
that IRS will do that, but we have hopes that it will, and we will
be monitoring this process.

Mr. LAUGHLIN. Your response has prompted a second question
and that is, you stated the IRS agent will prepare his or her ques-
tions for the taxpayer as they come in. It occurred to me that it
would also Speed up the whole time involved in the audit if the


120

to exaggerate. Because taxes are a vital component in our
economy, improvements necessarily will have wide ramifications for
everyone's pocketbook. Beyond the immediate functioning of the
economy, the way taxes are collected strongly influence public
attitudes towards government and our laws.

Since my FOIA litigation, IRS has taken some steps to make
TCMP more accessible to the public. ‘They now routinely release
tabulations and analyses they prepare from TCMP. For a time the
IRS had a program which allowed researchers, with IRS assistance,
to undertake their own studies. The agency also sponsored annual
conferences where IRS staff, tax professionals and academics
shared research findings. This cross-fertilization reduced the
insularity that had long plagued IRS. In recent years, however,
agency TCMP analyses have sharply declined and collaborative
research has diminished.

In these tight budgetary times I believe that one way that
TCMP research can be increased is by making TCMP micro-data files
available for analysis outside the agency. This would no way
impinge on individual taxpayer privacy. For many years, IRS has
sanitized micro-data files from its Statistics of Income program
and made them publicly available. Although IRS has argued that
access to TCMP micro-data would somehow impair its collection
strategies, these fears are largely misplaced. There is no reason
not to release historical files. For more current data, there are
numerous approaches that could be adopted to meet IRS concerns
while still allowing broad access.

REDUCING TAXPAYER BURDENS

It has been suggested in some quarters that TCMP is a burden

for the taxpayers who are selected for this special audit. Of
course this is true. In a similar way, serving on a jury is a
burden -- sometimes a big one. But being judged by a jury of

one's peers improves the chances of a fairer system for all. so
it is with TCMP, the existence of which can lead to a more
equitable and efficient tax system for all

Historically, TCMP has been mostly used for identifying ways
to modify the behavior of taxpayers. An equally important, but
under-utilized purpose, should be to identify ways the tax system
can be modified to help taxpayers meet their obligations with the
minimum administrafive hassle. I am not limiting this to only
changing IRS procedures. It is also essential that TCMP be used
to identify problems in the way Congress has written the tax laws
that impose unwarranted complexity or regulatory burdens. Two
examples of what I am talking about come to mind.

Everyone bemoans the many burdens imposed by the complexity
of tax requirements. But partly because the costs of these
burdens have not been quantified and the specific problem areas
identified, we have failed te confront this ‘ery grave problem.
This did not have to be the case. Past TCMP data, if properly
analyzed, could have provided detailed information about
components of noncompliance arising from unnecessarily complex tax
provisions.

4 The Center for Tax Studies at Syracuse University has pioneered
additional ways of measuring components of tax complexity keyed to
line items on tax returns filed by individuals. Research studies
show that tax complexity appears to be a major cause of the
differences between taxpayer reports and IRS TCMP auditor
findings. See Susan B. Long and Judyth A. Swingen, “The Impact of
the Tax Reform Act of 1986 on Compliance Burdens: National Survey
Results," in 2

i impli 2 Internal Revenue Service
Publication 7302 (1989); Susan B. Long and Judyth A. Swingen, "The



19

be part of the TCMP database. This effort should provide much
needed information on employment tax compliance as well as data
on the treatment of workers as independent contractors--an issue
that has suffered from the lack of statistical data and has been
the subject of extensive controversy.

Finally, IRS hopes to improve the data collection process. In
past TCMP surveys, auditors manually recorded audit adjustments
on a checksheet, which was later transcribed into the TCMP
database by district or regional office clerical staff. IRS
officials have long had a concern about errors that occurred
during this data entry process and were not detected until long
after the audits were complete. In the 1994 TCMP, for the first
time, all case data will be entered directly into computers. To
help ensure accurate data, IRS plans to have computer software to
do consistency checks that will alert the auditor to correct
errors while the audit workpapers are still available for
reference. Using such computerized input should reduce the
potential for transcription errors and improve the quality of the
data transmitted to the TCMP database maintained at IRS’ Detroit
Computing Center.

‘AY FT MP

The 1994 TCMP offers IRS an opportunity to obtain information on
the compliance characteristics of a broad segment of the
taxpaying population. It is important that TCMP proceed on a
timely basis because IRS’ compliance data are becoming quite old.
The longer the interval between TCMP surveys, the less useful is
‘CMP, given changes in the economy and the tax law. The latest
CMP surveys were made of 1988 individual returns, 1987 small
corporation returns, 1984 S corporation returns, and 1981
partnership returns. The 1994 TCMP, however, is not progressing
as smoothly as IRS expected.*

IRS has not met some of its key milestones, including testing of
the data collection system to be used for gathering data and
development of training materials. Consequently, the first
audits will be delayed at least one month, to November 1995.

-- IRS is developing two electronic checksheets or data
collection systems for TCMP. The Totally Integrated
Examination System (TIES), under development for use in the
regular audit program, is being modified to meet TCMP
specifications. Because IRS officials are not sure whether
TIES will meet the TCMP data requirements, IRS is also

*In December 1994, we issued a status report on the progress IRS
was making on planning for TCMP entitled Tax Cor

ce_Measureme; am (GAO/GGD-95-
39, Dec. 30, 1994).


14

TAXPAYER COMPLIANCE MEASUREMENT PROGRAM

SUMMARY OF STATEMENT OF
JENNIE S. STATHIS
DIRECTOR, TAX POLICY AND ADMINISTRATION ISSUES
GENERAL GOVERNMENT DIVISION
U.S. GENERAL ACCOUNTING OFFICE

Sound tax policy and administration decisions depend on
comprehensive, reliable, and timely information on taxpayer
compliance. For about 30 years, the Taxpayer Compliance
Measurement Program (TCMP) has been the Internal Revenue
Service’s (IRS) primary program for gathering such information.
IRS uses the data for measuring compliance levels, estimating the
tax gap (i.e., the difference between the amount of income tax
owed and the amount voluntarily paid in a year), identifying
compliance issues, developing formulas for objectively selecting
returns to audit, and allocating audit resources. Congress and
federal and state agencies use TCMP data for policy analysis,
revenue estimating, and research purposes.

In 1991, IRS proposed a much smaller TCMP because of criticisms
that it was too costly, too intrusive, and too untimely. GAO
reported in 1993 that IRS’ proposed changes would reduce the
TCMP’s usefulness and that the criticisms did not justify such a
major modification. GAO concluded that the additional revenues
generated because of tax law and administrative changes resulting
from TCMP analyses have far exceeded the cost. And while TCMP
audits may be intrusive, they affect relatively few taxpayers but
help many others avoid an IRS audit. While timeliness is of
concern, GAO concluded that IRS could speed up its analysis of
TCMP data if, for example, it validated data earlier in the
process.

IRS is getting ready to conduct the most comprehensive TCMP ever
undertaken. Currently planned to begin in November 1995, it will
include about 153,000 individual and business taxpayers. In
comparison to past TCMP surveys, this one should provide auditors
with more information and give them better tools with which to
perform more efficient, more effective audits. IRS hopes to
collect data for the first time on the reasons for noncompliance
and on the specific tax issues involved.

Some of the steps most critical to the success of this TCMP are
scheduled to occur within the next several months. ‘These
include testing the computerized data collection system and
training the auditors. If the planned computerized data
collection system does not work, a backup system may be used that
has fewer capabilities. However, even if the system does work,
IRS does not currently have enough computers for all of its
auditors to use it. To make the results most useful for
compliance research, IRS also needs to modify the TCMP database
to make available all the data the system can provide and
computerize the audit workpapers.


WAYS AND MEANS SUBCOMMITTEE ON OVERSIGHT

SCOPE OF THE HEARING:

‘The purpose of the hearing is to assess the value of the TCMP program to effective
tax administration and policy analysis, and to determine if there are less
alternatives available to the IRS to achieve the program’s primary goals. Testimony will be
received on the uses of the data, its timeliness, its availability for policy analysis, and
relevancy to fundamental tax reform. Testimony will also be gathered on the design, sample
size, cost and implementation schedule for the current TCMP survey, as well as the IRS's
readiness to meet that schedule, Of particular concem is the burden TCMP audits place on
taxpayers and whether taxpayers whose retums are selected for analysis should be
compensated for the costs they incur as a result of the audit.

In announcing the hearing, Chairman Johnson described the hearing as especially
relevant because Congress has not yet received reports on the findings of overall compliance
from the 1985, 1987 and 1988 TCMP surveys. "If this Subcommittee is to conduct effective
oversight of the IRS, it must have access to the information that will allow it to evaluate the
Service's allocation of its enforcement resources. The Committee on Ways and Means should
have the most up-to-date compliance data available as it reviews the effectiveness of current
law and proposals for legislative changes.”

"AILS FOR SUBMISSION OF EN

Any person or organization wishing to submit a written statement for the printed
record of the hearing should submit at least six (6) copies of their statement, with their
address and date of hearing noted, by the close of business on Wednesday, August 2, 1995,
to Phillip D. Moseley, Chief of Staff, Committee on Ways and Means, U.S. House of
Representatives, 1102 Longworth House Office Building, Washington, D.C. 20515. If those
filing written statements wish to have their statements distributed to the press and interested
public at the hearing, they may deliver 200 additional copies for this purpose to the
Subcommittee on Oversight office, room 1136 Longworth House Office Building, at least one
hour before the hearing begins.

FORMATTING REQUIREMENTS:

tach fer pearing ts the ty as, any wtten erent te the printed record or
‘ny writen comments In regpone io regent for writen comments ust conform ta tk guidelines Ustad below. Any statment or exhibit
‘ot compliance with theee guidelines wil not be printed, bot wil be maintained a the Comune fe for review and uae by the
Commie.

4, Al statements and any atconyenying exhbts fr prating moat be type Ia sngle apace oo lgalsie paper and may wot oxcded& tt
(C10 page indading anachmes,

‘2 Copies of whole documents submited exibit mata wil not be accep for printing. Instand exhlbt matralsboud be referenced
‘nd quota or paraphrased All xiblt mata not meeting thate specifications wl be maintained tn tbe Cammlioe os fer review and
‘se by te Comte

Aes anpmg a ye arg ebating «eta Weed ol heg eng wits cme a
response 8 Fequat for trae ‘mast inelde oa ls et of al iets, pervs, ot
‘rquniatons am whose behalf th witness appara.

‘4 Acupplemeatal shoot must accompany each statement sting th came, fll adree, x talophone wamber where che witness or te
reproentatir may be reached and a pla] culine or wemmary of the comments and recommendation Lt te ful statement
‘hls enppleetal sot wil not bo incinded tm the penta record.

appty ony to satel being or patiog. Stateceas and ext
Siesta yt a seh, ee en sr ba on

Note: All Committee advisories and news releases are now available over the Internet at
*GOPHER.HOUSE.GOV’ under ‘HOUSE COMMITTEE INFORMATION’.


132

noncompliance. No other source can provide this key distributional information as accurately
‘as can the TCMP.>

Steven Klepper and Danie! Nagin at Carnegie Mellon University have also used compli-
ance patterns at the line-item level to analyze how the likelihood of detection and the severity
of penalties affect compliance levels.‘ Moreover, because the TCMP data allowed them to
compare line items, they could explore the possibility of substitutions effects. Do taxpayers
with opportunity for noncompliance on some aspects of their returns tend to be noncompliant
in other areas, or does the opportunity for noncompliance, for instance on income reporting,
“substitute” for noncompliance in other aspects, for instance the overstating of deductions?
Interestingly, they found evidence for such substitutions effects, an analysis that could best be
done with TCMP data, In general, there is not a high positive correlation between compliance
on one part of a return and compliance on other unrelated parts. As they note, “We believe
our analysis demonstrates that disaggregnting noncompliance tothe level ofthe lin item on
the tax return can be very revealing.”>

Several researchers have also used TCMP data to explore the roles various types of tax
preparers and practitioners play in tax compliance patterns.° Klepper and Nagin again used
the detailed line-item patterns of compliance to determine that practitioners tend to increase
compliance with relatively unambiguous aspects of returns where noncompliance is likely to
be detected and adjusted by the IRS, while they seem to increase the likelihood of more ag-
gressive positions in ambiguous areas with low likelihoods of detection. In our own analyses
we found that the apparent relationship between practitioners and overall noncompliance is
misleading. Individuals with complex financial and tax situations are both more likely to be
noncompliant (either intentionally or unintentionally) and more likely to use tax practitioners.
‘When one uses the detailed data in the TCMP to control for the complexity of the tax situa-
tion, one finds that the net effect of practitioners is to decrease overall noncompliance. In far
more detailed and sophisticated analyses, Michael Udell has found similar patterns.

‘The Research Division of the IRS and the General Accounting Office have occasionally
used the working papers from TCMP audits to obtain a fuller understanding of the problems
with areas of high noncompliance. For instance, the working papers have been used to trace
why exemptions for dependents were being disallowed (e.g., generally inadequate documenta-
tion and record-keeping or misinterpretation of the law) and to examine the problems with
capital gains and losses (¢.g., inadequate documentation for the basis, incorrect calculation of
the basis, misinterpretation of the laws for carry forwards and carry backs, etc.). Such analy-
ses can be extremely valuable in planning administrative and legislative responses to problems,
but drawing the information from working papers is inefficient and labor intensive. From my
work with Oregon state auditors, I know that similar information can be obtained much more
efficiently through check sheets completed by the auditors for targeted issues—if the analysts
and auditors cooperate in designing the check sheets and if the auditors understand and are
committed to the utility of the information. This is an extension of the TCMP audits that I
think should be used more often.

3. American Bar Association Commission on Taxpayer Compliance (1987), “Report and
Recommendations on Taxpayer Compliance,” Tax Lawyer 41: 329-92

4, Klepper, Steven, and Daniel Nagin (1989), “The Anatomy of Tax Evasion,” Journal of
Law, Economics, and Organization 5:1-24.

5. Ibid, p. 23

6. For example, Graetz, Michael, Jennifer Reinganum, and Louis Wilde (1989), “Expert
Opinions and Taxpayer Compliance: A Strategic Analysis.” Social Science Working Paper
‘No. 710. Pasadena: California Institute of Technology. Klepper, Steven, and Daniel Nagin
(1989), “The Role of Tax Practitioners in Tax Compliance,” Policy Sciences 22: 167-92.
Udell, Michael A. (1991), The Effects of Tax Preparer Use on Non-Compliance with the Fed-
eral Individual Income Tax (dissertation), Pasadena: California Institute of Technology,
Division of the Humanities and Social Sciences. Smith, Kent W. (1988), “Tax Practitioners
and Taxpayer Compliance: A View from Intensive Tax Audits,” at the Annual Conference of
the Socio-Legal Group, Oxford, England, March 23.


110

what happened. I do not draw the same conclusion IRS does—I
draw a conclusion that says the credit is too low. If the credit were
$2,500, they all would have thrown grandma from the train.
(Laughter.]

But for $40 a month, it is not worth it.

Mr. PorTMAN. Are they not throwing themselves from the train,
too? Because it raises the whole issue of the Social Security tax.

Mr. LaNE. Well, no, they may not even have grandma doing the
baby sitting in the house. They may be taking them to a next door
neighbor. But for $40 a month, if you talk to most working couples,
the biggest problem they have is this child care hassle and the last
thing they are going to do is disrupt one that is working for a $40
a month tax credit to play “rat fink” on the baby sitter. So the bot-
tom line is that the credit was too low and a lot of people looked
at that and said, no, I am not going to do that. I had people say,
“Tam not going to give you that number, just take the credit off
the return.”

So to turn around and draw the conclusion afterward that oh,
our great TCMP provided this dramatic $1.2 billion additional reve-
nue because we got all of these tax cheaters off the rolls, is abso-
lute nonsense.

I am not accusing them of being disingenuous with the sub-
committee. I am just saying, this is an example of the myopia the
organization has. They take these backward looks at situations and
say, oh, well, our TCMP suggested this is a problem.

The primary reason they wanted this tax law change for the TIN
was that they only had 260,000 people in the country file tax re-
turns indicating they derived income from child care. There are
probably 260,000 in the city of Washington that are making child
care income. So they knew they had a problem and they knew that
they would get better compliance if you asked for the tax ID num-
ber. I do not think that it had anything to do with TCMP.

Mr. PorTMAN. Well, that just goes to the difficulty of making
some of these estimates, not just looking back but looking forward,
which is even more problematic as Mr. Keating has said, 3 years
from now when we have the data available we may well have an
entirely different tax system to be working with.

Thank you, Mr. Chairman, I appreciate the testimony.

Mr. HANCOCK. Thank you.

Well, thank you, very much, to the panel. We most likely have
another vote on so we will recess temporarily and the next panel
will be seated and we will be back in about 15 minutes.

{Recess.]

Mr. HANCOCK. I want to welcome the next panel. I am not going
to make formal introductions. Your written testimony will be made
a part of the record. I would appreciate it if you would try to be
as concise as possible and maybe we can wind this up by about
3 p.m., and maybe before we get another vote over there.

Would you please proceed, Dr. Scheuren.


69

area, should have greatly reduced levels of noncompli-
ance.”

The important point is that the 19868 TCMP has
hindered, not helped, thoughtful analysis of the EITC.
The 1994 TCMP will come far too late to affect the EITC
reform discussions currently under way. Given the cur-
rency and importance of this issue, all concerned would
be better served by a well-designed and properly executed
research program that might be completed this fall.”

4. in needs of ot

gers. Another argument often advanced in support of the
1994 TCMP is that it will serve the needs of other users
such as the General Accounting Office, the Joint Commit-
tee on Taxation, the Treasury Department’s Office of Tax
Policy, the Commerce Department's Bureau of Economic
Analysis, various state governments, and private sector
researchers.

As a preliminary matter, of course, anyone who
relies on data always wants more. The question is wheth
er the benefits of additional data justify the costs of
collection. With respect to uses directly related to the
tax system, we do not believe that the either IRS or
these other potential users have made the case. We be-
lieve that the principal objectives to be served by the
1994 TCMP could be achieved more effectively and effi-
ciently, at less cost to the government and with less
burden on citizens.

One way to attempt a "cost-benefit" analysis as
it relates to other potential users of the 1994 TCMP data
would be to ask them the following question: how much
would you be willing to compensate the IRS and taxpayers
for costs they incur due to the 1994 TCMP?

III. Conclusion: A Suggested Alternative We
believe the IRS, taxpayers and tax administration would
be better served by abandoning plans for the 1994 TCMP.
Quite simply, we are not persuaded that the likely bene-
fits will offset the certain costs to the government and
taxpayers.

While TCMP has served a useful function for
many years, it was designed in a different era to meet
very different needs. During the past 25 years, research
techniques, technology, and the tax system itself have
all changed dramatically. Efforts to "improve" TCMP are

* We are aware of the January 1994 study showing that
noncompliance levels are improving but remain rather
high. In our view, that study suffers from the sane
flaw as all TCMP data -- it reflects the IRS posi-
tion on audit, not a final determination. It also
illustrates the danger of targeted "research" stud-
ies that are neither well designed nor well executed
(e.a., a small sample of returns filed during two
weeks in January). Compliance research projects
should not be a hasty response to external pressure;
they should be the result of well-conceived research
strategies.

” See, note 9, supra.


APPENDIX I APPENDIX I

E
Improved (GAO/GGD-93-145, Sept. 24, 1993)
We found that EITC appears to be achieving its goals. Those
workers who receive the credit and are below the poverty line have
their overall federal tax burden substantially reduced, while those
qualified workers who are above the poverty line have their taxes
reduced somewhat. Also, work incentives for some workers appear to
be enhanced by the credit. However, we also found that one-third
of the taxpayers who received the credit were not entitled to it.
This occurred primarily because tax filers claimed the wrong filing
status. We recommended that IRS modify the tax return to capture
all the requisite qualifications information. We used TCMP data to
determine the magnitude and types of erroneous EIC claims that IRS’
processing procedures could not detect.

1 Bette; Al (GAO/GGD-94~
175, August 2, 1994)

Sole proprietors account for a disproportionate share of
noncompliance. Although only 13 percent of individual taxpayers,
they account for an estimated 40 percent of the noncompliance. We
found that IRS did not have a comprehensive compliance strategy for
sole proprietors. We noted that IRS could better use existing TCMP
data to identify root causes of noncompliance. We demonstrated
this by using TCMP data to look at the causes of noncompliance for
truckers and automobile body repair shops. We recommended that IRS
develop pro forma recordkeeping for truckers and ensure that
insurance companies provided information returns on payments to
automobile repair shops.

ti for Se: viders (GAO/GGD-95-59,
December 28, 1994)

Using the 1988 TCMP and the broadest definition of service
provider, we estimated that between 0.2 million and 1.6 million of
the 11.5 million service providers may be misclassified employees.
The estimate of the 1992 income tax gap for the: vice providers
ranged from $21 billion to over $30 billion. If those
misclassified workers were reclassified as employees, a significant
amount of the taxes owed would likely have been withheld by the
employers. IRS studies have indicated that taxpayers subject to
withholding were substantially more compliant.



143

1455 PennsyWvania Avenue, NW
Washington, OC 20004-1084

(202) 737-6600
Fax (202) 638-4512

0-1-226

August 1, 1995

Members of the House Ways and Means
Oversight Subcommittee

United States House of Representatives

1136 Longworth House Office Building

Washington, DC 20515

Dear Sir/Madame:

The AICPA appreciates the opportunity to comment on the value of the Taxpayer Compliance
Measurement Program (TCMP). We believe that the TCMP is an essential element in the Internal
Revenue Service’s audit program and should be continued. A TCMP audit is a time-consuming
process, both for the taxpayer and the agent, but its benefits outweigh the costs through more
efficient tax administration, While these audits impose substantial added burdens on those taxpayers
selected, they should help countless other taxpayers avoid an audit completely through the
accumulation of statistically valid baseline data.

As you are aware, it has been six years since the last TCMP survey. The TCMP is one of the
comerstones of the voluntary compliance system, In a tax system that requires the filing of a return,
and when less than 1% of those returns are audited, the enforcement authority (the IRS) must have
a method by which to measure compliance and target enforcement efforts. The TCMP aids the IRS.
in this goal. With the data provided by detailed “random” audits of a statistical sampling of returns
filed, the IRS can hone its enforcement efforts to select those returns for an audit which are most
likely to be in noncompliance.

Any cost-benefit analysis of the TCMP audit is speculative, at best. The TCMP began with the
examination of 92,000 individual tax returns from tax year 1963. The TCMP survey planned for the
1994 tax year is projected to examine 153,000 returns, For the first time, the sample will be drawn
from 28 major market segments, enabling the IRS for the first time, to look at compliance within each
market segment, regardless of the type of tax return filed. Of the 153,000 returns selected for an
audit, 92,000 are intended to be individual tax returns and 61,000 are intended to be corporate and
partnership tax retums, These 92,000 individual tax returns represent fewer than 03% of
nonbusiness individual returns and fewer than 1% of business individual returns. Nonetheless, the
IRS must take steps to ensure that taxpayer inconvenience is minimized for those selected and ensure
that taxpayer selection is truly random. While the taxpaying public at large benefits, the incremental
inconvenience to the audited taxpayer is severe, as can be the incremental costs.


10

April 1998. Since most of the examination work will occur in Fiscal Years 1996 and
1997, our costs will be greater in those fiscal years. In Fiscal Year 1996, we
estimate that approximately 23.5 percent of our total revenue agent and tax auditor
staffing will be devoted to TCMP examinations. In Fiscal Year 1997, this will
decrease to 16.4 percent with a further decline in Fiscal Year 1998 to 7 percent of
the total revenue agent and tax auditor staffing.

Although this TCMP survey does require a fair amount of examination
tesources, GAO has stated that the concern that TCMP is too costly has little merit.
The more effective allocation of enforcement resources and additional
recommended tax law changes that data from TCMP will provide should generate
millions more in revenues than the cost of the TCMP survey.

TCMP audits carefully review all aspects of the tax return and the extent to
which it rof.ucts the taxpayer's true tax situation. However, our examiners do have
flexibility as to the depth that this review must take. Thus, we balance the need for
accurate data with the burden this places on the taxpayer.

The IRS has considered alternative ways to capture the data we need to
administer the tax system, including gathering enforcement data from operational
programs; conducting numerous, specific studies; and conducting opinion surveys.

While these alternatives would provide some measure of compliance, there
are a number of shortcomings to such data. The alternatives we have
investigated -- and tried ~ have not proven up to the task of supporting accurate,
verifiable compliance measures.

Uses of TCMP Data by the IRS

New data that is statistically valid by market segment and geographic area is
critical to enabling us to focus our compliance efforts on the most non-compliant
taxpayers. With this new information, IRS resources will be applied more effectively
and consistently -- geographically, within market segments and by issue.

The IRS uses TCMP data to

Develop DIF formulas to identify and select retums for examination that
have the highest potential for tax change;

Identify emerging noncompliance trends,

Identify compliance problems which can be corrected through
legislative change;

Assign resources to the areas with the highest noncompliance; and
Develop tax gap estimates.

Earlier in my testimony, | shared with this Subcommittee the impact that
TCMP has had with respect to the development of DIF formulas -- a significant
reduction in the percentage of returns that are examined and result in no change to
the reported tax liability.

Now, | would like to share three examples of how TCMP results have
uncovered compliance problems which were addressed through legislative changes.
First, through data compiled by TCMP, the IRS identified a problem with the number
of dependents being claimed, This discovery resulted in legislation that required a
Social Security Number for dependents claimed as exemptions. This legislative
change, effective for tax year 1987 returns, resulted in 7 million fewer dependents
being claimed in 1987 -- an estimated $2.9 billion in additional revenue.

Another compliance problem identified using TCMP data was the overstating
of the child care credit. Again, legislation was enacted requiring the taxpayer
claiming the credit to provide a taxpayer identification number for the child care
provider. In tax year 1989 (the effective date for the legislation), 2.7 million fewer
taxpayers claimed the credit yielding $1.2 billion in additional revenues. Also,
252,000 new taxpayers began filing Schedule Cs as child care providers which
resulted in $343 million in additional seit-empioyment and income taxes.

Finally, by using TCMP data, we discovered that taxpayers were not fully
reporting their state tax refunds. Through a legislative change requiring the states
to file an information return (Form 1099G) with the taxpayer and the IRS, tax year
4989 retums reported additional income from state refunds resulting in $144 million
in additional tax revenues.

These examples represent the importance of TCMP data to IRS’ compliance



141

Sere SEE _ Congress of the Uniter States gz
Hee: RSS ess of the Ginited

{818 LONGWORTH HOUSE OFFICE BURLOING.
Wasmaron, OC 20616-8469
(202) 225-9621

AUG 01 1995

Honorable Nancy Johnson
U.S. House of Representatives
Washington, DC 20515

Dear Mrs. Johnson:

You have requested information relating to how the Joint
Committee on Taxation ("Joint Committee") uses the Taxpayer
Measurement Compliance Program (*TCMP") files of the Internal
Revenue Service ("IRS") in preparing revenue estimates for many
tax compliance proposals. This letter contains a brief
description of the 1988 TCMP file followed by some examples of
how the Joint Committee has used the TCMP data.

The 1988 Individual TCMP contains approximately 54,000
individual tax returns for 1968 that have been extensively
audited. These returns were chosen to be a statistically
representative sample of the 107 million individual returns filed
for tax year 1988. The TCMP examination covers every line item
of the tax return. In contrast, routine IRS examinations focus
on specific, and generally predetermined, items on tax returns.

The resulting TCMP data set contains both the taxpayer-
reported amounts and the IRS examination-recommended amounts.
The data are particularly well suited to the analysis of
information reporting proposals because amounts reported on
information documents can be compared with amounts reported by
taxpayers to measure taxpayer reporting compliance. Moreover,
the data include verified occupation categories for each tax
return. Taxpayer-reported occupation categories are accurately
reported on only about one third of individual income tax
returns. Verified occupation categories are quite useful for
proposals that target specific types of taxpayers, such as
independent contractors.

The IRS uses the TCMP information as a planning tool to
determine its workload, to understand areas in which taxpayers do
not accurately report amounts that the Service believes should be
reported and to estimate how much individual income tax should
have been paid. TCMP data are also used to develop the system
that selects returns for audit. One result of the TCMP-developed
audit selection system has been a dramatic decrease in the
Percentage of audited returns for which no change in tax
liability was found.


APPENDIX II APPENDIX IT
Table I re le St 0.
0. ni
Market Sample size
segment Percent
population | Form ALL that are
Market segment, (000) 1120ss_| returns_| 112088
Nonbusiness--no CY) 0 5,042 0.0
schedules
Nonbusiness--no 0 o} 15,175 0.0
Schedules C, E, or F
Nonbusiness with ° C) 7,958 0.0
Schedule E
Very small business 0 0 5,105 0.0
Farm business 37 591 8,602 6.9
Building trade 109 598 5,851 10.2
contractors
All other 80 594 6,049 9.8
construction
Manufacturing 121 595 6,313 9.4
Mining and minerals 47 597 3,457 17.3
Agricultural services 25 596 3,067 19.4
Wholesale trade un 595 7,792 7.6
Direct sales to not C) 1,595 0.0
individual available
Auto and boat dealers 46 596 3,965 15.0
and service stations
Food and_beverage 135 597 4,931 12.1
Apparel, furniture, 40 596 3,540 16.8
and general
merchandise
Retail--all other 128 593 4,268 13.9
Real estate 204 594 5,759 10.3

Source: Final 1994 TCMP Sample Design.


98

Statement of
David L. Keating
President
National Taxpayers Union Foundation
on the
Taxpayer Compliance Meastirement Program
before the

Subcommittee on Oversight
‘Committee on Ways & Means
U.S. House of Representatives

July 18, 1995

Thank you for the opportunity to testify on the Taxpaye= Compliance Measurement
Program (TCMP). National Taxpayers Union Foundation represents 300,000 members
who are concerned about the faimess of the tax audit and collection process.

Representative Johnson, we commend you for scheduling this hearing to examine
the proposed 1994 Taxpayer Compliance Measurement Program. As you know, the
upcoming TCMP is scheduled to review 153,000 returns, substantially more than previous
TCMP surveys.

As L worked to prepare this statement, I sought comments from several professional
tax practitioners who are informal advisors to our organization. I am especially indebted to
Kip Dellinger, who is a partner at Dellinger & O'Connell, a Los Angeles based CPA firm.

Writing in the June 5, 1995 Tax Nates, George Guttman reports that the next
“TCMP is expected to cost approximately $280 mullion in FY 1996 and require 4.388 staff
years. This will break down to 4,248 revenue agent staff years, or 26 percent of agent
Tesources, and 140 tax auditor staff years, or 5 percent of auditor resources.” Not counted
in the IRS’ cost estimates, of course, is the value of the time spent by taxpayers and their
tax professionals. Given the rigorous nature of a TCMP audit, these costs are likely to be
‘even larger for the taxpayer.

Please keep in mind how arduous a TCMP audit is. How many of the married
members of this subcommittee can quickly locate their marriage license? Remember, that is
just the first item on the tax return, and is one of the easiest to document. If the IRS
reviews all the deposits made in your various banking, checking, or mutual fund accounts,
how easy would it be for you to document the source of all funds deposited and
transferred?

Docs TCMP have a garbage-in, garbage-out problem?
‘Gutiman notes that “TCMP data reflects selected audit results only. No subsequent
TCMP change is made when a taxpayer successfully contests an adjustment with the IRS

Appeals Office or through litigation. Overall. the sustension rate for issues that go to
Appeals or Litigation is no more than 50 cents or less on the dollar.”

Essentially this means that the TCMP data can be used to flag tax returns where the
IRS can claim a tax adjustment, not whether it can win such an adjustment. Given recent
GAO criticisms of the knowledge of tax laws by ta auditors, this Would seem to call into
question the reliability of the raw TCMP data.

A recent paper by Dan Pilla for the Cato Institute notes the different standards
between the auditing process and the cases reviewed by the Appeals Division. He notes
that “of the cases received by the Appeals Division in 1993. nearly 97 percent were settled
by agreement. That is to say, while the taxpayer was unable to reach a satisfactory
settlement with the tax auditor, he could with an Appeals officer 97 percent of the time.”
Pilla says the reason why taxpayers often come io an agreement with an Appeals officer “is
found in the cules governing practice before the Appeals office.” Pilla quotes the language
of Rule I:

“An exaction by the U.S. Government which is not based upon law,
statutory or otherwise, isa taking of property without due process
of law. in violation of the Fifth Amendment to the U.S. Constitution.


140

size of the contribution made by the donor and provide a good faith estimate of any goods
and services rendered in exchange for the contribution, Before this change in the tax law,
the taxpayer needed only to have a cancelled check as validation for a charitable contribution
deduction. The TCMP data showed that charitable contribution deductions are frequently
and substantially overstated, and showed how the overstatement of charitable contribution
deductions was distributed by size of contributions. These data proved crucial in estimating
the effects of alternative proposals to detect overstatement of charitable contribution
deductions, including the specific one that became law.

‘The TCMP data also were very helpful in estimating the revenue effects of requiring
mortgage brokers to file information reports to the IRS on the proportion of property taxes
paid by the buyer and the seller in the course of a home sale. Previously, it was possible for
both the buyer and the seller of the house to claim a deduction for the entire amount of
property taxes paid on the house in the year of the sale. While the TCMP data did not
directly measure compliance for this specific type of deduction, compliance under this
proposal could be inferred from examination of compliance in the reporting of the home
mortgage interest deduction, an item whose compliance is measured by the TCMP. Thus,
even if the revenue effects of a compliance proposal cannot be estimated directly from the
‘TCMP data, it may be indirectly estimated by using a closely related TCMP compliance-
measured income or deduction item.

These are just a few examples of how OTP uses TCMP audit data to determine where
additional information reporting would be particularly helpful and in estimating the revenue
consequences of such changes. To the extent the quality of the TCMP data is maintained at
a level consistent with the primary objectives of the program -- the determination of
taxpayer compliance levels, the appropriate allocation of IRS audit resources, and the
selection by the IRS of specific tax returns for audit -- the TCMP data will continue to meet
OTP’s requirements. Conversely, if the TCMP program were reduced or compromised to
the point where it no longer accomplishes these objectives of the IRS, OTP’s ability to rely
on the data would also be adversely affected. Were that to happen, our ability to propose
improvements to the tax system and provide accurate revenue estimates would be reduced.


91

income. It is precisely with respect to identifying undisclosed in-
come where we see the greatest weakness in TCMP.

In a rudimentary sense, conducting a TCMP is akin to “preach-
ing to the choir.” It provides data about what taxpayers are deduct-
ing. It provides little in the way of identifying income never re-
flected on the return, and it provides nothing about taxpayers who
never file. It is precisely the problem of underreporting and non-
reporting of income that so fuels the average taxpayers’ frustra-
tions with the current tax system.

Any voluntary compliance system depends on the perception that
everyone is paying their fair share. When it becomes common
knowledge that there are many members of society not participat-
ing, it undermines the support for the system among those who do
comply.

The Service has begun to focus on those segments who are not
complying through the use of the market segment specialization
program. We believe this approach is a wise one and believe that
compliance will result from approaching taxpayers on an industry-
specific basis.

Using a market-driven approach also permits taxpayer education
when appropriate, and identifies legislative changes which could
increase compliance. The Service clearly recognizes these factors
and more and more returns are being selected based on market.
segment data and not the DIF score.

We think the DIF score will continue to decline as a primary se-
lection mode for the Service, so we question why they have to go
through the traditional way of running a TCMP.

There are many commercial data bases now available which will
permit the Service to develop profiles of specific industries and will
allow them to target taxpayers who do not meet industry ratios for
examination. These external data sources contain management,
tax, and financial data which could be factored into a model devel-
oped by local DORAs, the District Office Research and Analysis,
and lead to more productive audit leads than random selection.

Another example of technology appeared in last Monday’s Wall
Street Journal where they report that a Halifax, Nova Scotia, ac-
counting professor used something called Benford’s Law to identify
fraudulent financial transactions by scoring the deviation from a
random selection of when numbers appear in a given sequence. The
story in the Wall Street Journal indicated that the District Attor-
ney’s Office in New York has used this to prosecute fraud. We are
not recommending that the IRS adopt this, but it is just an exam-
ple of where they could take another technique and apply tech-
nology a little more efficiently to the process.


MN

activities. We believe that the information from the planned survey will have even
far more reaching results in terms of our effectiveness in increasing tax collections
through a combination of voluntary payments and IRS collection efforts.

Uses of TCMP Data by Others

TCMP data is also used by other agencies in the Executive and Legislative
Branches of government, such as:

+The Bureau of Economic Analysis (BEA) uses tabulations of TMP

data in conjunction with other data to adjust national income and
products accounts;

The Joint Committee on Taxation uses TCMP data to estimate
potential revenue gains from tax proposals intended or expected to
affect compliance;

The Department of the Treasury uses TCMP as a tool in developing
tax policy proposals and in estimating revenue effects of proposals to
improve taxpayer compliance; and

‘The GAO uses TCMP data for a variety of studies.

In addition, two states have obtained the relevant portions of our TCMP data
files for studies of compliance with their income tax laws.
Conclusion

In conclusion, our goal is to improve our detection of noncompliance; to more
effectively assign our resources to the areas with the highest noncompliance; and to
identify compliance problems which can be corrected through legislative change. To
achieve this goal, the IRS needs data that is statistically valid within market
segments and on a geographic basis. The best methodology that we have identified
for securing this data is TCMP.

The IRS is on target to implement the upcoming survey on time. | assure you
that we will meet the challenge of conducting these examinations in a timely manner
with the least possible burden to taxpayers.

Madame Chairman, this concludes my prepared remarks. 1 would be happy
to answer any questions you or other Subcommittee members may have.


97

centive to make the TCMP process more efficient because it has ig-
nored the value of the taxpayer’s time and expense in designing
this program.

It should be of little surprise that the IRS has not given proper
weight to those costs in designing this particular TCMP. When
public opinion pollsters, when they want to go into a lengthy exam-
ination—and one of the big problems public opinion pollsters are
finding today is getting people to cooperate—where they want to do
more detailed multihour focus group they have to pay people in
order to get them to attend.

What we have here is the IRS is going to conduct the Nation’s
most tedious and expensive focus group, but instead of paying the
people to participate they are actually going to force them to pay
hundreds or thousands or tens of thousands of dollars for the or-
deal, and that does not even count the potential tax that may be
collected.

We believe that if the IRS thinks that gathering this data is so
important, then it should pay taxpayers for the time and expense
of submitting to such a TCMP audit. This will give the agency an
incentive to design a TCMP survey that efficiently considers the
use of all national resources, not just the agency funds.

I would also like to briefly express some concern about the use
of the TCMP data by the IRS and the Congress. We cannot think
of a single instance since 1986 where the fRs has made a single
legislative proposal based on the last TCMP survey.

Even though everyone knows there is a problem with EITC, the
IRS actually sent out EITC refunds to taxpayers who did not even
qualify for the program.

In conclusion, we think that before undertaking another TCMP,
especially the one that is going to be the largest ever, the IRS
should be required to study other less intrusive alternatives. The
TCMP, as it presently exists, is overly burdensome on taxpayers
and arbitrary in the selection process.

By the time meaningful results can be derived from this pro-
gram, the information that will be gathered may well be obsolete
or irrelevant by the passage of comprehensive tax reform.

Thank you very much.

{The prepared statement follows:]


102

Mr. HaANcock, Thank you all for your testimony. There are a few
questions that we would like to get in the record, and I have got
a lot of questions about this. But in the interest of time, Ms. Smith,
from your testimony I kind of get the impression that you feel that
this just basically is the price of citizenship.

Ms. SMITH. Very much so. That is how I was raised and it is a
theory that I have come to embrace myself. That is not to say that
I did not think it was the audit from hell or that I want to do it
again. [Laughter.]

Mr. HANCOcK. Kind of like a root canal?

Ms. SMITH. I, given a choice between this and a root canal, I
would take the root canal, I think. I have had one of each.

But, yes, it is important to me to pay my taxes, to do it correctly
as best I can and to participate in the system. It was not my judg-
ment and nobody asked me in 1981 if this was the best way for
the IRS to do its business, they just said this is what we are doing
and you are in it, and I was glad to participate.

Mr. Hancock. Well, do you think that,you should have been re-
imbursed for your expenses?

Ms. Smitu. I do not think there is enough money to reimburse
anybody for the kind of time and stress that it puts you through.
But having thought about this question in the past week, I think
it would have been nice if I had had, for instance, a voucher that
would have given me one-half hour of some CPA’s time for a con-
sultation, something like that. Perhaps, even something to show
appreciation like a method of filing electronically for free for the
next 5 years, would have been nice. Not unlike what Nielsen did
when they asked me to write down a television log for a week.

Mr. Hancock. Well, what would have been your attitude if, in
fact, they had said, yes, you got a trip back to Jackson for this
audit.

Ms. Situ. I do not believe I was given any choice. The records
were my responsibility and it had been my decision to leave the
records. I never thought about going into an audit. I just was mov-
ing and left the records behind because I did not think I would ever
need them again. I did have the forethought to keep them, thank
goodness.

If I had had to make some arrangements to & back and get
them I would probably have had friends of mine dig out the boxes
and try to do something that I could afford to do.

Mr. Hancock. It could have been a little bit different, though,
if, in fact, you had been out several thousand dollars?

Ms. SMITH. Oh, yes. Everybody's circumstances would be dif-
ferent. If this had pappened to my mother it would have been a
disaster.

Mr. Hancock. Mr. Lane, you indicate, in your testimony, that
there is value in focusing on the economic reality of the taxpayer's
lifestyle if it is inconsistent with the income, the level reflected on
the return.

Does this not raise your concern that the TCMP process does lit-
tle to identify income not reflected on the return?

Mr. Lang. Yes. It does address our concern. We are concerned
that since TCMP just applys to taxpayers who file, there ought to
be better systems devised to identify taxpayers who are not filing


118

STATEMENT OF SUSAN B. LONG
DIRECTOR, CENTER FOR TAX STUDIES
SYRACUSE UNIVERSITY, SYRACUSE, N.Y.

Madam Chair and members of the subcommittee, thank you for
requesting my testimony. The fair and efficient operation of our
federal tax laws is a matter of central concern to every American.
I very much appreciate the opportunity to present my views on what
I consider a vital component in this system: the Internal Revenue
Service's Taxpayer Compliance Measurement Program (TCMP). My
testimony is divided into three areas: (1) the fundamental
importance of TCMP in efforts to improve the fairness and
efficiency of the federal tax system, (2) the need for improved
access to TCMP data in reaching these goals, and (3) specific
suggestions for how TCMP could be used to help reduce unnecessary
taxpayer burdens.

My acquaintance with TCMP goes back longer than I like to
remember. ‘Twenty-five years ago, when I was a graduate student at
the University of Washington, I first sought access to TCMP data
from the Internal Revenue Service for my research on taxpayer
compliance and IRS operations. At that time, no TCMP information
was publicly released by the IRS. Indeed, the General Accounting
Office complained that it could not obtain access to even
aggregate TCMP statistics. Because IRS did not voluntarily
release TCMP data when I requested it, my husband and I ultimately
filed suit in 1975 against the IRS under the Freedom of
Information Act. This suit eventually was successful in forcing
the public release of over a million pages of TCMP statistics,
agency internal reports and analyses, details on the sample
designs, and computer tapes containing the underlying checksheets
(after deleting taxpayer identities) made out by IRS auditors on
many of the returns covered by TCMP studies.

While I have long been viewed as a critic of the IRS, after
years of research I remain convinced that TCMP is one of the most
important government initiatives aimed at making our tax system
work in a more efficient, fair and less intrusive manner.

WHY IS TCMP SO IMPORTANT

The Taxpayer Compliance Measurement Program is essential
because without it the IRS, Congress, and the public would be
flying blind about the operation of the government's central
function -~ tax collection.

"The revenue’ of the state is the state,“ wrote Edmund Burke,
the eighteenth-century statesman and historian. Put another way,
without the legal authority to collect taxes and the compliance of
citizenry to these laws, government is a sham. It is this fact --
that taxes are profoundly essential to the existence of all
successful states -- that makes information about the functioning
of our tax system essential. Without reliable and valid
information, tax collectors’ actions may be misguided and
ineffective, citizens may be unduly burdened or unfairly treated,
and the citizens' elected representatives wili be hampered in
their attempts to correct these failings. Without the continued
and systematic monitoring of how our tax system is working, we
will not recognize problems until they have become festering
social and economic problems. Without solid grounding in the
facts, actions designed to improve cur tax system and its
administration are less likely to produce their intended results

How can we obtain reliable and valid information about the
true functioning of our tax system? Congress has long recognized
the need for such information. Encountering difficulties in
getting the information it desired out of the Treasury Department
after federal income tax laws were instituted following approval
of the Sixteenth Amendment to the Constitution in 1913, Congress
mandated that government prepare and publish annual statistics
about the operations of the federal income tax laws. The
Statistics of Income (SOI) program was born in response to this


65

* Improvements in sampling and statistical tech-
niques suggest that the IRS’ "scoring" objec-
tives could be satisfied with samples that are
both much smaller and more narrowly targeted
than the proposed TCMP universe (particularly
if such studies were conducted more frequently
and completed more quickly) .°

Stated differently, the key question that must be asked
is: Given current IRS "scoring" techniques, alternative
ways to improve those techniques, and the projected level
of audit coverage, do the reasonably anticipated benefits
of the 1994 TCMP justify the costs to the government and
the costs and other burdens to be imposed on taxpayers
taking into account the time it will take to complete and
evaluate the effort? Maybe that case can be made, but
based on information provided by the IRS and others to
date, we believe the answer is no.

Even if that question were answered "yes," and
the proposed 1994 TCMP were the most cost effective way
to improve the general audit program, a second question
still requires an affirmative answer. Budget realities
force the IRS to make hard choices and set priorities.

In light of all the other efforts that the IRS could
pursue to improve voluntary compliance and/or reduce
taxpayer burden, is the 1994 TCMP the best place to
allocate scarce resources? Once again, it may be possi-
ble to make a case for the 1994 TCMP. But once again, on
the information provided to date by the IRS and others,
we believe that the answer is no.

2. Measuring the tax gap and its
components. While TCMP was not originally intended for
this purpose, it has been used for some time as a basis
for estimating the overall tax gap and its components
Here again, TCMP may have a useful purpose. We now know
that:

* In absolute dollar terms, the aggregate tax gap
is quite large.

* Most noncompliance involves the underreporting
of income.

© Compliance levels are extremely high in circum-

stances where there is withholding, and rela-
tively high when there is effective information
reporting and matching.

© Compliance levels are low in circumstances
where there is the opportunity to understate
tax, such as where there is no withholding and
no effective information reporting. It is even
lower when the medium of payment is cash and
the payor has no need for any record to sub-
stantiate payment for purposes of a tax deduc-
tion or a reimbursement claim.

* For example, Professor Bradley Efron, Department of
Statistics, Stanford University, has suggested that
sample sizes as small as 1,000 might be sufficient
for most purposes.


71

Chairman JOHNSON. Thank you very much, Mr. Goldberg.
Mr. Gibbs.

STATEMENT OF LAWRENCE B. GIBBS, PARTNER, MILLER &
CHEVALIER; AND FORMER COMMISSIONER, INTERNAL
REVENUE SERVICE

Mr. Gipsps. Madam Chairman, it is also a pleasure for me to be
here with you today.

I will get right to the point. I rarely disagree with my good friend
Fred Goldberg. On this issue, however, we are in disagreement. I
would like to pinpoint, though, where we disagree.

I think the function that these hearings will perform is a good
function. I think it is time that we take a hard look at TCMP. It
has grown and changed over the last 30 years, and I think it is ap-
propriate that it continue to do so. I would not suggest that we
abandon TCMP, but I would suggest—and I agree with Fred in this
regard—that there are problems, there are deficiencies, there are
shortcomings.

The only thing that I would say is this. I would put it to you this
way: While I was Commissioner from 1986 to 1989, there were two
questions that I was asked by taxpayers, the media, and the Con-
gress: No. 1, I was asked what is the level of taxpayer compliance
with our tax law in this country? No. 2, how much are we losing
in taxpayer noncompliance? I felt I had to have credible answers
based on something that taxpayers and others would feel is credi-
ble in order to respond to those questions.

My point is that, with all of its faults and all of its shortcomings,
TCMP is better than anything that has been suggested to replace
it as an alternative. I would simply say that, in addition to Com-
missioners being asked those questions, I suspect you are asked
those questions by your constituents. I know I was asked those
questions by your predecessors, and it is important to have not
only answers, but credible answers, answers that come from a com-
prehensive overall credible methodology to provide answers.

If we can change that methodology, if we can make it better, fine.
But we had better not abandon the methodology until we have
something else in place. To suggest that we do so before we have
something else in place I think is inviting trouble that can lead to
disrespect and lack of confidence—even more than is reported that
we have at the present time.

So, for that reason, I would say improve TCMP and change it,
change it drastically, but, for goodness sake, do not abandon it
until we have an overall comprehensive credible system that will
provide the results that TCMP is presently providing to the folks
that are using those results.

Thank you.

[The prepared statement follows:]


16

TCMP data, IRS identified a significant compliance problem with
the number of dependents claimed on tax returns. IRS reasoned
that this problem could be mitigated if dependents’ Social
Security Numbers were required to be entered on tax returns. The
1986 Tax Reform Act required this entry for most dependents
claimed. The Joint Committee on Taxation estimated that this
change would generate an additional $300 million in tax revenues
annually. IRS has estimated that, as a result of this
requirement, taxpayers claimed 7 million fewer dependents on
their 1987 tax returns than they did the year before.

TCMP data also allow IRS to estimate the tax gap and its
components. The tax gap is the difference between the amount of
taxes owed and the amount of taxes voluntarily paid in a year.
TCMP data are used to identify the compliance levels with all
types of income and deductions and these are the data from which
tax gap estimates are constructed.

TCMP data are also used outside IRS to (1) estimate the revenue
impact of proposed legislation; (2) adjust the national income
accounts, such as the gross domestic product; and (3) conduct
research on tax compliance. We have made extensive use of TCMP
data in our own analyses of tax administration issues. For
example, we used TCMP to identify problems with the Earned Income
Tax Credit and erroneous dependent and filing status claims. (A
summary of reports in which we made use of TCMP data can be found
in appendix I to this statement.)

CRITICISMS OF TCMP

In 1991, IRS decided that, despite its many benefits, TCMP had to
be changed to make it less costly, less intrusive on compliant
taxpayers, and more timely in producing results. IRS officials
believed that these concerns were significant enough for them to
undertake a major effort to redesign TCMP. By September of 1992,
IRS officials had proposed cutting the sample size by half--to
about 25,000 returns for individual taxpayers. IRS officials
also proposed modifying TCMP procedures so that not all tax
return lines would be audited. In addition, IRS began developing
other programs to replace TCMP data, including proposals to use
data from operational audits and non-IRS databases to identify
noncompliance.

In an April 1993 report, we noted that while these concerns had
some validity and TCMP could probably be improved, our analysis
of TCMP cases and IRS’ support for its concerns led us to believe
that these problems were not as significant as IRS asserted.*

We reported that TCMP was not too costly because past TCMP

sure Tax Comp] ii
Improved (GAO/GGD-93-52, April 5, 1993).


99

Accordingly, an Appeals representative in his conclusion of fact or
supplications of the law, shall hew to the law and the recognized
standards of legal construction. It shall be his or her duty to determine
the correct amount of the tax, with strict impartiality as between the
taxpayer and the Government, and without favoritism or discrimination
as between taxpayers.”

Pilla notes that “incredibly, no similar guidelines exist for tax auditors.” In other
words, the people who will be compiling data for the TCMP are not operating under nules
requiring the type of strict impartiality that is the standard for the Appeals Division.

‘The timing of this TCMP is poor.

‘We believe that there is a very good chance that the next Congress will pass
fundamental reform of the current income tax law. The current income tax may be replaced
altogether by a national sales or flat rate tax. Both the House Majority and Minority leaders
have proposed a fundamental restructuring of the tax laws as have the chairmen of the
Ways & Means and Senate Budget committees. With the likelihood that the tax laws will
be fundamentally restructured, and soon, the timing of this TCMP is questionable at best.

werly burdes ers

As described by the IRS, taxpayers are selected for TCMP audits on a random basis
within stratified taxpayer filing groups. Yet these taxpayers are subjected to what can
become an enormously time consuming and costly audit process. It takes an enormous
amount of time to assemble the documentation of every line item on a tax return, In many
cases, itis necessary for the taxpayer to retain a professional for representation. In other
instances, taxpayers do so simply out of fear. or in cesponse to the overwhelming and
intimidating information requests that accompany TCMP examinations.

Because of the nature and extent of TCMP examinations, professional fees can be
extremely expensive and will generally exceed the cost of preparation of the returns
themselves several fold. While a $280 million program is, by federal government
standards, a paltry expense — the costs of a TCMP to individual taxpayers or small
businesses can become almost punitive

When so many other methods, resource, and tools are avaiiable in the IRS arsenal
‘of weapons to be used against errant taxpayers, it is patently unfair to put a random group
of taxpayers through the rigorous, sometimes ridiculous and very expensive process that
TCMP entails for statistical purposes.

‘TCMP design should account for all costs, and taxpayers should be compensated.

To the extent that the IRS is allowed to proceed with the presenily contemplated
TCMP program — the government should be required to compensate both taxpayers and
any professional representatives they engage for their time and effort. Care should be taken
to advise taxpayers selected for a TCMP that they will be compensated for their time and
that if they choose to retain a professional representative they will be reimbursed for
reasonable professional advisors’ fees.

In designing this TCMP and projecting its cost, the IRS is pretending that there is,
no cost for the taxpayer's time and the expense of hiring a professional. That is unwise
and uneconomic for the country.

‘Guttman’s article notes that statistician Amir Aczel “contends that the DIF
[discriminate function} analysis has been superseded by more powerful statistical methods,
such as ‘logistic regression,” which requires less data. Aczel claims 20,000 audits can
provide the same type of information that the IRS will get from the 153,000 plan for the
1994 TCMP.” Guttman reports that “Aczel says the IRS" plan for the next TCMP is like
doing exploratory surgery with stone-age tools.”

Guttman also cites “Don Rubin, chairman of the Statistics Department at Harvard
University {who] argues that nobody knows whether Aczel is right.” He writes that Rubin
helieves “the best that an outside statistician can say is that the IRS approach can be made
more efficient.”

Yet the IRS has little incentive to make the process more efficient because it has
ignored the value of taxpayers’ time and expense. It should come as no surprise that the
IRS has developed a TCMP that statisticians think can be made raore efficient, since most
of the expense would be borne by the unlucky taxpayers who will be selected for this,
arduous audit



21

IRS has estimated that it would cost about $1.7 million to
provide the additional 425 computers and related furniture needed
to properly equip tax auditors. IRS officials said that funds
are not available to make these purchases. IRS has thus
encouraged the districts where tax auditors do not have computers
with TIES capability to canvas their districts for computers that
can be given to tax auditors doing TCMP audits.

We are concerned that the districts may not find enough computers
and will therefore use either more costly revenue agents to
conduct the audits or have tax auditors use the less efficient
backup collection system.

We are also concerned that IRS will not be taking full advantage
of all TIES features for TCMP purposes. IRS officials told us
that the “other expenses" and the “other income" lines on
business returns are often adjusted during audits, sometimes
relating to more than one type of expense or income. Using TIES,
auditors may assign codes that identify the specific reason and
related tax issue for each type of adjustment made to these
lines. However, only one adjustment code will be put on the TCMP
database at the Detroit Computing Center.

We were told that the TCMP database would have to be modified to
accommodate more than one code and that it would be too costly to
do so. However, it may be possible to create a subsidiary file
that could be attached to the database that would allow
additional codes to be captured. IRS may want to consider this
option so that these data can be used for compliance research
purposes.

Similarly, TIES allows for computerized workpapers, with detailed
information on reasons for noncompliance and audit techniques
used. However, according to IRS officials, while auditors are
required to use the TIES data collection feature, IRS cannot
require auditors to use the TIES workpaper feature because the
union contract gives auditors the option of generating workpapers
by hand. In our 1994 TCMP status report, we suggested that IRS
find ways to make workpapers available through electronic media
so that the workpapers would be readily available for compliance
research.

IRS agreed to explore the feasibility of at least retaining the
disks in cases where auditors use computerized workpapers. We
are not aware of any action that IRS has taken on this issue.
Better, more efficient compliance research could be done if all
audit workpapers were computerized and readily accessible to
researchers.


50

compliance, where the noncompliance issues are, if we are going to
reach our goal of increasing collection of that revenue base.

Mr. Levin. Thank you. t think between your comments in that
response, I think it helps one understand why we are here today,
and I am glad we are.

Thank you.

Chairman JOHNSON. For the record, I would note that this is the
largest TCMP ever proposed. It is about three times as large as
any program they have ever done. It is also structured differently
and I think will give us better information. It is also going to go
on over 24 to 30 months, and all of us on this side of the table are
going to hear about it as a result of that.

There are a couple of questions that I want to complete for the
record. There are then two votes on the floor, so we will recess be-
tween, this panel and the next panel until the second vote is con-
cluded.

There are three matters that I think did not get sufficiently clari-
fied. First of all, would the IRS have any objection to a sanitized
data base being prepared and made available to qualified research-
ers outside the Service?

Mr. BRAND. I believe that that is a Treasury tax policy question,
Madam Chairman, but we would be glad to provide the answer for
the record.

Chairman JOHNSON. If you would do that, I would appreciate it.
Also, if you would include in that how long you think that would
take. That would be useful to us. At the same time, if you could
be specific about when you expect you could get information back
to this subcommittee and over what sort of schedule, that would be
useful to us, too.

[The information requested was not available at the time of
printing.]

Chairman JOHNSON. Then there is the issue of the other expense
line that GAO raised, and I do not believe we discussed adequately.
The other expense line covers a multitude of problems, and it is
one of the reasons why there is too little detail in that area, the
lack of detail under other expenses will make it hard for us to
judge issues like the misclassification of workers.

Could you comment, Ms. Stathis, on why you think more infor-
mation ought to be available under other. Mr Brand, if you want
to comment on any problems for the IRS in further detailing that
section, I would be interested. To me, this is more important than
workpaper issues. The workpapers I can appreciate researchers
might like, but that is going to be a horrendous amount of informa-
tion.

The other line it seems to me is very important, particularly in
terms of spotting patterns of problems or patterns of noncompli-
ance. We are dealing with some of the issues that frankly this sub-
committee is really concerned with.

Ms. STATHIs. That is right. The parallel issues with other ex-
penses and other income, it is sort of a catchall line where people
put a lot of things. Unless there is enough information to separate
out exactly what all was put there, it can be misleading as to what
is really being observed.


95

‘There are many commercial data bases now available which would permit the
Service to develop macro-economic profiles of specific industries for purposes of
targeting taxpayers who do not meet industry ratios for examination. These external data
sources contain management, tax and financial data which could be factored into a model
developed by the local District Office Research and Analysis (DORA) teams and lead to
‘much more productive audit leads than random selection. In addition, the benefit of not
putting taxpayers who are complying through the agony of the process needlessly would
acerue to the Service’s credit

We believe that additional focus should be given to using technology in identifying
targets for examination. By way of illustration, an article appeared in the Wall Street
Journal on July 10, 1995 (page B1) which discussed the process an accounting professor
in Halifax, Nova Scotia is using to help identify tax cheating and other financial fraud. He
‘uses an obscure numerology theory known as Benford’s Law, which lays out the statistical
frequency with which the numbers 1 through 9 appear in any set of random numbers. The
Jaw is applied to suspicious checks or tax returns to see if the numbers are truly random or
invented, This process has been employed by the District Attorney in Brooklyn, NY in
prosecuting check fraud in seven companies and the professor consults with Canadian and
other taxing authorities. I discussed the applicability of this law to tax auditing with an
‘accounting professor colleague this past week and he agreed that for certain tax schedules,
like Schedules C or F or E, the theory should be predictive. He pointed out however, that
‘wage data and charitable contributions would not work because one is more likely to find
umbers ending in 0 or 5 in these two categories than a random sample would have
predicted. We are not recommending that the Service adopt this procedure but use it
merely to illustrate that there are alternative ways of approaching issues we used to
depend on manual processes to accomplish.

‘Recommendations

‘We would like to see a true cost benefit analysis of the current plan for the
upcoming TCMP. It should include some approximation of the cost to taxpayers to
participate in this statistical-gathering exercise as well as the staff years and resources of
‘the Service. The true cost should then be compared with alternative ways of gathering
data using commercially available business resources, such as Dun & Bradstreet, SRIs
Values and Lifestyles Studies, etc.

‘We would like to see taxpayers who are subjected to a TCMP compensated for the
cost of their participation. We are aware that this has been discussed before and that some
Service officials have expressed some support for compensating taxpayers who emerge
from the process with a no-change. We are concemed that this would provide incentive
for agents to find some issue to disagree on just to escape the reimbursement process. in
principle, we would like to see all taxpayers receive some compensation for their
involvement since their inclusion was based on a random selection and not the result of
any indication that they deserved to be audited. Of course, we can understand the
Service’s position that this would have to balanced against the results of the examination
‘We can well imagine the Service balking at the prospect of compensating someone who
they are in the process of criminally prosecuting. Pethaps the remedy is to compensate up
to a certain level of proposed deficiency only. We would like to see further study of this
proposal.

Closing
We appreciate the opportunity to offer our comments about the Taxpayer

Compliance Measurement Program. We offer our assistance to provide any additional
information raised by these comments or other areas of concern.


33

Chairman JOHNSON. Thank you, very much.

There are a number of questions that we would like to pursue
and the first of them focuses on this issue of whether the IRS is
on target in implementing the upcoming survey. The GAO reports
that the Service did not meet its June milestone of testing the data
collection, nor did it meet its March expectation of having training
materials available.

Mr. Brand, would you like to comment?

Mr. BRAND. Yes, I would, Madam Chairman.

We will have the training materials developed by August 1. The
training is scheduled for September and October and we do not an-
ticipate any problems with that. I do not recall the milestone being
earlier, but if it was, it was.

In terms of the data collection and gathering process, we have
developed something we call TIES which is our automated system
for revenue agents. We have been concerned because of a lack of
computers in all of our offices, so we did design a backup system.
That backup system is in place and we will be able to gather the

lata.
So I believe we have met the GAO concerns. We did work with
them on the audit. We have been responsive to the audit rec-
ommendations and I believe we are on target to commence.

Chairman JOHNSON. Would you like to comment, Ms. Stathis?

Ms. STaTuHis. We are hopeful that TIES will work for TCMP be-
cause it does online data consistency and validity checks as the
data is being entered.

It also automatically generates the audit report, so the taxpayer
will have it immediately at the end of the audit and know what the
results are. Because of their automatic generation, the amount of
work that the auditors have to put into doing the reports will be
reduced. So we are really hopeful that TIES will work for the
TCMP and that IRS will not have to use the backup system for any
of the audits.

I think this is one of the issues with having enough computers.
Having enough will allow TIES to be used for all of the TCMP au-
dits.

Chairman JOHNSON. But is it true that you have not tested your
system of collecting this information, and so while you have a
backup system, you do not know whether your planned system is
even going to work and you have not tested the backup system?

Mr. BRAND. We believe we have tested it sufficiently to know
that it will, in fact, work. The issue is, can we get enough comput-
ers to some of our front-line employees? We are looking now for re-
direction of computers from other areas.

What we will probably end up with is a mix with our most dif-
ficult cases being done by the TIES system. We will use some of
the other cases that are not as complex. We may need to use those.
But in both instances, again, the data gathered will be the same,
it will be loaded in an automated manner, it will be analyzed in
an automated manner. The real difference is the generation of the
examination reports we will be able to do electronically through
TIES. If we do not have TIES, we will have to generate the exam-
ination reports manually; that is the difference.


1838

These are just some of the many examples of the valuable analyses that can be done with
TCMP’s detailed data on a statistically sound sample of taxpayers—analyses that could not be
done as well with other types of data. The TCMP potentially offers answers to far more ques-
tions than the IRS"s Research Division can explore. But the analyses can now be distributed
more widely within with Service. During the first 20 years of the TCMP, analysis involved
specialized programming on a mainframe computer, and the primary emphasis was on produc-
ing a general purpose set of tables, The output literally stood several feet, and retrieval ex-
perts were needed to find the relevant information in the tables, and then the general purpose
tables often did not provide direct answers to one’s questions. With today’s powerful micro
computers and statistical programs, analyses tailored to specific questions take just a matter
of minutes. They can be done by staff members with training in data analysis and the special
problems of working with audit data. With the promising development of DORA sites, I hope
that the Service will distribute more widely the facility for analyzing the data and thereby take
much fuller of advantage of the rich TCMP data than it has been able to in the past. For this
distributed analysis to be effective and efficient, however, researchers in the National Office
will have to expand their functions to also be consultants on TCMP analyses, and there will
need to be some mechanism for sharing analysis plans and results among DORA sites.

‘Two Essential Characteristics of with TCMP

The plans for the 1994 TCMP involve many improvements over previous cycles, and the
program can be improved even more. However, in evaluating and modifying the TCMP, I
think there are two essential characteristics that must be retained if itis to remain a useful tool
for identifying and analyzing compliance patterns, These same characteristics are probably
also critical for an efficient and accurate data base for developing statistical models for audit
selection, such as DIF; but my focus is on the other administrative and legislative uses of
TCMP.

1. Probability Sample of Taxpayers. To draw valid inferences about noncompliance, the
‘TCMP data must include a statistically representative and sufficiently large sample of taxpay-
ers who are compliant on a particular item so that their characteristics can be contrasted with
those of a sample of taxpayers who are not compliant. Therefore, the program must involve a
probability sampling of taxpayers that at some level of stratification is independent of the like-
lihood of noncompliance.

2. General Audits of Taxpayers’ Finances. The starting point for TCMP audits must be the
total financial and tax situations of the taxpayers during the tax year being audited. The
‘TCMP auditors should not be given the latitude to focus on just those items that they think
may be relevant. If they do, there will be a selection bias at the level of the line item even
though it may be a statistical unbiased sample of returns.

There are several interrelated reasons why these essential characteristics should be re-
tained.

‘+ First, adequate pictures of the incidence of noncompliance and of the factors related to
noncompliance have to be based on the contrast between statistically sound samples of
cases of noncompliance and of cases of compliance. One cannot determine how non-
compliance differs from compliance by only or primarily looking at cases of noncom-
pliance. Without a probability sampling and general audits, TCMP would provide a
biased and misleading picture, both of the relative amount of noncompliance and, per-
haps more importantly, of the factors affecting the noncompliance.

+ Not all under and over compliance is reflected in the returns as filed and in third-party
reports. Using only this information to select returns and issues will give an incom-
plete and misleading picture. To give some examples, evidence from TCMP and sur-
vey data indicates that there are appreciable numbers of individuals with small business
on the side but who file 1040s without Schedule C and even 1040As or 1040EZs.
Understatements of income by amounts too small to show up in expenses or living
standards is widespread and, in the aggregate, a significant source of noncompliance.
Individuals and businesses, for one reason or another, often do not list relevant ex-
penses, but an accurate picture of compliance patterns should include such over com-
pliance,


7

results had been used to more efficiently allocate billions of
dollars in enforcement resources and to recommend tax law changes
that generated millions of dollars of revenue a year. We also
noted that the burden was small compared with the benefits
derived from the TCMP audits. We pointed out that TCMP audits
actually reduced the audit burden on taxpayers not included in
CMP to the extent that the use of TCMP data reduced the number
of compliant taxpayers selected for other IRS audits. We also
noted that IRS could speed up its analysis of TCMP data if, for
example, it validated data earlier in the process.

We concluded that the proposed changes to the size and scope of
CMP would undercut its significant benefits. Moreover, IRS
itself recognized the value of TCMP as an important source for
objective compliance data. Out of this recognition came a new
TCMP covering tax year 1994 returns that is larger than previous
surveys and for which audits are slated to begin in late 1995.

94 CMP.

HENSIVE

The 1994 TCMP will be the most comprehensive TCMP effort ever
undertaken. With a sample of about 153,000 income tax returns,
this TCMP is designed to obtain compliance information for
individuals, small corporations (i.e., those with assets of $10
million or less), partnerships, and S corporations.’

Previously, IRS had done separate TCMP surveys for each of these
entity types.

IRS estimates that the TCMP will cost about $559 million in
direct costs over the next 3 fiscal years (1996-1998)--about 16
percent of IRS’ estimated $3.4 billion examination budget--and
about $1.5 billion in opportunity costs, which are the revenues
that will not be realized from conducting regular audits. While
the primary purpose of TCMP audits is not to produce revenues,
IRS also estimates that the revenue yield from these cases will
be about $685 million. The 153,000 taxpayers that will be
audited represent about 1/10 of 1 percent (0.1 percent) of the
125 million individual and business taxpayers covered by this
TCMP. Thus, relatively few taxpayers will be burdened by TCMP
audits. These audits are scheduled to begin in November 1995 and
be concluded by May 1998.

The 1994 TCMP sample will stratify tax returns by market segment.
A market segment represents a group of taxpayers with similar
characteristics, such as those in manufacturing, regardless of

?an 8 corporation is one taxed similarly to a partnership. A
qualifying corporation may choose to be generally exempt from
federal income tax. Its shareholders then include in their
income their share of the corporation’s separately stated items
of income, deduction, loss, and credit.


61

JOINT STATEMENTS OF FRED T. GOLDBERG, JR.,
MICHAEL J. GRAETZ, AND THOMAS M. GOLDSTEIN
AS PRESENTED BY FRED T. GOLDBERG, JR.

Madam Chairman and Members of the Subcommittee:

We appreciate the opportunity to submit this
statement on the subject of the IRS’ proposed Taxpayer
Compliance Measurement Program for the tax year 1994 (the
"1994 TCMP"). We are submitting this statement solely in
our individual capacities and not on behalf of any client
or organization.

In brief, our views are as follows: (1) It is
universally acknowledged that the 1994 TCMP will be
expensive and intrusive, and will take a long time to
complete and evaluate. (2) The case has not been made
that the reasonably anticipated benefits from the 1994
TCMP will justify either its cost to the government or
its burden on taxpayers. (3) The benefits likely to
result from the 1994 TCMP could be achieved more effec-
tively and efficiently through other IRS research and
enforcement strategies.

I. What We Know About TCMP We should begin
with what we know about the proposed 1994 TCMP. It is a
major investment of resources by the IRS; it will impose
a substantial burden (without compensation) on taxpayers
unlucky enough to be selected for TCMP audits; and it
will take years before we learn anything from the effort.

A. Cost to the Government The IRS esti-
mates that the 1994 TCMP will cost approximately $550
million over three years, more than six times greater
than the cost of the 1988 TCMP. To put this number in
perspective, it represents more than 30% of what the IRS
would like to spend over the next three years on the
supplemental revenue initiative that was approved by

2 Mr. Goldberg is currently a partner with the law
firm of Skadden, Arps, Slate Meagher & Flom. He has
served as IRS Commissioner (1989-1991) and as Assis-
tant Secretary Tax Policy (1992). Professor Graetz
is currently the Justus S$. Hotchkiss Professor of
Law at Yale Law School. He has served as Deputy
Assistant Secretary (Tax Policy) (1989-1991) and
Assistant to the Secretary and Special Counsel
(1992). Mr. Goldstein is currently a student at
Yale Law School and a summer associate with Skadden.
Arps, Slate, Meagher & Flom

In the interest of full disclosure, Mr. Goldberg
notes the following: (1) Mr. Goldberg’s comments
during the hearing itself reflect solely his own
views, and may not necessarily reflect the views of
Professor Graetz or Mr. Goldstein. (2) While Mr
Goldberg is testifying in his individual capacity,
the concerns expressed in the written statement and
his testimony are the same as those he raised as IRS
Commissioner and as Assistant Secretary (Tax Poli-
cy). (3) Mr. Goldberg was the "Commissioner" who
was referenced in the 1993 and 1994 General Account-
ing Office ("GAO") reports on TCMP. 1: iministra
tion: TRS’ Plans to Measure Tax Compliance Can Be
Improved (GAO/GGD-93-52, Apr. 5, 1993), and Tax
Compliance: Status of the Tax Year 1994 Compliance
suremen mm (GAO) /GGD-95-39, Dec. 30, 1994).



130

Whether or not one should do that now, this round, I am not en-
tirely convinced because we have a lot of catchup, for instance,
since 1981 for partnerships, and can we afford a small sample at
this point?

Finally, even if fundamental tax reform occurs, there will still be
a need to monitor and analyze compliance with something like a
TCMP involving statistical samples of taxpayers and general au-
dits. I also think current TCMP data could be used far more than
what it currently is to evaluate the compliance implications of the
various reform proposals.

That concludes my statement, and I will be happy to answer any
questions.

(The prepared statement follows:]


114

‘TCMP data; therefore, 1 will be brief.

Unquestionably, TCMP data have considerable value -- notably for policy makers
and for the economists who maintain the U.S. National Income and Product Accounts.
Uses, of course, by the IRS over the years have been many, including such statistical
‘measures as the tax gap; even so, the operational application of TCMP data can be
frustrating. Among the reasons I have heard for this are —

‘© TCMP’s (perceived) lateness and the fact that, in the meantime,

© —_Legisiative or other changes may have intervened - making it hard to know how to
employ the results

Documentation issues may exist too, as 1 have leamed personally, if one wishes to make

comparisons over prior TCMP studies on topics not looked at earlier.

AA strength of TCMP is that it is comprehensive in scope. This makes it possible to
rank by importance the compliance issues IRS faces -- even to use the rankings to help the
agency set priorities for employing its scarce resources. On the flip side, sample sizes for
some compliance areas of concen may be insufficient to provide enough detail to inform
action, Even when the samples are large enough, they may not be frequent enough to decide
whether legislative or administrative changes had the desired effect. The alternatives
implicitly here are either more frequent TCMP studies or a series of single issue studies.
Both probably are needed -- I will return to this point later.

The complexity of mounting such a large statistical effort as TCMP within an
operating environment is daunting. That it has been done and done well over the years is a
real achievement. Nothing I have to say below should be interpreted as contradicting this;
nonetheless, many improvements may be possible. ¥ will mention a few here,
Organizational Issues. -- Historically, each TCMP has had an ad hoc structure, with many
‘new individuals involved in a temporary endeavor. Though carefully trained, each study's
workers have mainly been first-timers. It is, moreover, a commonplace within the IRS that
‘TCMP is seen as interfering with the real work of the agency. Issues of organizational
learning, therefore, exist in this environment; the process of trying to make continuous
improvements may have slowed (even suffered) as a consequence.

Operational Concems.-- The upcoming TCMP is particularly vulnerable to concems about
the likely quality of the work to be done, given the long time between studies. Typically, in
statistical projects of this size a full scale "dress rehearsal” would be carried out before
fielding such an ambitious effort. I have not seen all the extra management controls IRS will
Pat in place to carryout is ambit ous goals Maybe iT had, L would not fel the way 1 do:

7 IRS not go fo ¥
{A szable pilot makes sense instead (perhaps onthe order of 10% or 30 ofthe current
planned effort).
Sample Design -- Some time ago, I saw the TCMP sample design and talked to the
statisticians who developed it. Incidentally, 1 was still an IRS employee at that point; my
“need to know" involved work I was then doing to manage the statistical aspects of the
1993 EITC Studies (which you have heard about at various points over the last year), While
I questioned then, and still question, some of the 1994 TCMP planning assumptions, my
impressions of the sample design work done are that it is of an exceedingly high calibre. My
recommendation above that a pilot be conducted would allow time to test some of these
design assumptions. The idea of market segment stratification, for example, is an inspired
one but not fully tested--more a hunch than a scientific conclusion.
Sample Selection. -- Because of the antiquated nature of IRS computer processing, the
TCMP sample, as well done as it is, still may not be adequately targeted. A two-stage
design might be beter approach:
‘The current TCMP sample would continue to be selected as now. Once drawn, case
files would be built (adding information documents, etc.) ~ again as is now
underway.
© From this initial large sample a subsample would be selected, presumably better
targeted because more information could be employed in its selection. (This
subsample might be the pilot sample mentioned earlier.)
‘Sample Estimation. -- Issues have been raised about the size of the TCMP sample. Does it
need to be so large? My answer to this is I do not know, but I suspect that more looking at
‘modern ways to make survey estimates could pay off in (at least somewhat) reduced sample


116
Mr. HANcock. Thank you, and now we will hear from Ms. Long.

STATEMENT OF SUSAN B. LONG, PH.D., DIRECTOR, CENTER
FOR TAX STUDIES, SYRACUSE UNIVERSITY, SYRACUSE, N.Y.

Ms. Lona. I will summarize my statement that I have submitted.
I basically have three points. No. 1, that I think TCMP is tremen-
dously important and should be continued.

No. 2, that I think we could get a lot more mileage out of TCMP
if we had broader public access to the data, and hence, more people
looking at it.

No. 3, I have some specific suggestions as to how we might use
TCMP creatively to reduce overall taxpayer burdens.

My acquaintance with TCMP goes back a lot longer than I would
like to remember. When I was a graduate student 25 years ago, I
first sought access to TCMP data from the IRS for my research on
taxpayer compliance and IRS operations. At that time, no TCMP
information was made available publicly by the IRS and indeed,
the GAO complained because it could not get aggregate statistics
from TCMP.

Because IRS did not voluntarily release it, my husband and I ul-
timately filed suit in 1975 under the Freedom of Information Act
and we were, after very lengthy litigation, ultimately successful
and forced the release of over 1 million pages of TCMP statistics
reports as well as some microdata files.

My first point is that I really think that after all of this time,
while I have often been viewed as a critic of IRS, I think TCMP
is a tremendously important program and should be continued. I
go into this, in some depth, in my written testimony and many of
those points were already covered and I will not emphasize them
here. But basically the bottom line is we really do not have a sub-
stitute yet for the idea of random selection. TCMP may be able to
be improved but the basic concept of TCMP remains and should be
continued.

I also want to point up something that was not in my written
testimony but came up in earlier questions in other panels as to
the underground economy. The TCMP that these hearings are fo-
cusing on concerns individual and corporate returns that are filed.
But TCMP has also been used to go after the nonfiler program. The
last survey on that topic was in 1988. So it is possible for this
mechanism of random selection to be used to examine the problem
of nonfilers.

Now, the second point that I want to make is how we might get
more out of TCMP. While I view TCMP as an essential tool for
good government, one question must be examined, Have we gotten
the most mileage from it? I do not think we have. It would be sur-
prising if there was not room for improvement in any government
program.

One very simple, but obvious point, is that for the information
to have value it must be distributed and used. Because IRS, for far
too long, sought to restrict access to this data, society has not
reaped the benefits from TCMP that are possible. Even within the
agency, itself, the insights provided by TCMP data have not been
sufficiently exploited.


4

Chairman JOHNSON. Good morning, the hearing will be con-
vened. I welcome you to our hearing on the Taxpayer Compliance
Measurement Program.

For 30 years, TCMP, the Taxpayer Compliance Measurement.
Program, has been the Internal Revenue Service’s primary program
for gathering information on taxpayer compliance with existing tax
law. The Service has used this information primarily to improve its
selection of cases to be audited and on occasion to seek legislation
to address specific problems. Tax policy and administration depend
on comprehensive, reliable, and timely information on taxpayer
compliance with existing tax law.

The IRS is now prepared to initiate a new taxpayer compliance
program, the biggest one yet. Its purpose is to gather information,
not only for audit selection but for better use of all of its resources,
including taxpayer assistance and education. Today we look for-
ward to testimony that will describe the comprehensiveness and re-
liability of the information that will be gathered.

But timeliness is an issue for which this subcommittee finds tes-
timony unnecessary. The TCMP studies have been carried out in
1985 on individual and S corporation returns, and in 1988 on cor-
porations, exempt organizations, delinquent returns, and again on
individual returns. Seven years later, this subcommittee has yet to
receive reports analyzing these findings.

There has to be some agreement on the timely delivery of infor-
mation to the Ways and Means Committee so that it may be used
by those who legislate tax policy and to the subcommittee so that
it can perform adequate oversight of the IRS.

We would also look forward to hearing comments from the wit-
nesses on the imposition of a requirement that the IRS report to
Congress a comprehensive analysis of its findings in a timely man-
ner, and further that the data be made more easily available to
independent researchers in order to achieve greater and more inde-
pendent analysis of the data.

TCMP studies have been described by some as too costly, too
time consuming, and too burdensome. Certainly, the requirement.
that taxpayers document every item on their return is burdensome.
I have been told that taxpayers are even required to provide their
marriage certificates to prove they are married. If the information
gathered through the TCMP is necessary to the development of
good tax policy and good tax administration, it is appropriate to
ask if there are more efficient and less burdensome means of gath-
ering that information.

TCMP audits are costly to taxpayers whether it is the cost of the
taxpayer’s own time or whether that of a hired tax professional. In
addition, the audits seem as unfair for those whose returns show
no indication of a need for an audit. We have to ask ourselves, is
it fair for government to place a burden and expense on innocent
people in order to better identify those who may not be so inno-
cent?

Should taxpayers be compensated for their participation? If so,
how would that best be accomplished?


93

‘STATEMENT OF JOSEPH F. LANE, ENROLLED AGENT
ON BEHALF OF THE NATIONAL ASSOCIATION OF ENROLLED AGENTS

Madam Chair Johnson, Ranking Member Matsui, members of the Subcommittee
on Oversight, my name is Joseph F. Lane and I am an Enrolled Agent in private practice
in Menlo Park, California. I thank you for your invitation to testify on behalf of the
National Association of Enrolled Agents regarding the Taxpayer Compliance
Measurement Programs conducted by the Internal Revenue Service.

1 am testifying today on behalf of the 9,000 plus Members of the National
Association of Enrolled Agents (NAEA). As the members of the Subcommittee well
know, Enrolled Agents are the only tax professionals possessing a Federal license to
represent taxpayers before the Internal Revenue Service and our Members represent more
than four million (4,000,000) individual and small business taxpayers annually, NAEA is
especially appreciative of the interest this Subcommittee has taken in the matter of Internal
Revenue Service practices and procedures, and their impact on taxpayers and we pledge
‘our support to further assist the Subcommittee in the future on issues which affect the
general taxpaying public.

‘TCMP: The Historical Perspective

The historical justification for the conduct of Taxpayer Compliance Measurement
Programs has been to permit the Internal Revenue Service to hone its selection criteria for
tax returns in need of examination. Decades ago when the TCMP was first employed
there was ample proof it was needed - the IRS was experiencing a non-change rate
between 30% and 40% of returns audited. This, all agreed, was a waste of both the
taxpayer’s and the Service’s time and resources. Over the years the repeated cycle of
TTCMPs has enabled the Service to increase its ability to forecast which tax returns are
more likely to produce a change if examined and they now achieve a no-change rate of
approximately 11%.

In addition to reducing non-productive audits another result of using the data
gleaned from TCMPs was the fact that the Service could insure some degree of uniformity
in the application of enforcement efforts across the country. T remember sitting in the
peanut gallery in this very room some twenty-three years ago when I was working at the
IRS National Office and listening to then Assistant Commissioner for Examination,
Singleton B. Wolfe, state to the Ways and Means Committee that it didn't matter if the
taxpayer lived in Augusta, Maine or Augusta, Georgia; they had the same chance of
getting audited because of the DIF score process. At that time it was important to reassure
taxpayers, and their elected representatives, that there was a uniform application of
enforcement across the nation

It also was a recognition of the fact that there was no other way of approaching,
the task. The technology to permit more sophisticated data searches was still in its nascent
stage. Alternative data bases did not exist to permit the Service to consider other means
of devising an audit selection criteria. The computing power of the Service even then was
‘woefully deficient, In short, there was no means other than an intensive, line by line probe
into tax returns selected at random, This entailed a great expenditure of staff years on the
part of the Service and an uncalculable amount of time, cost and lost opportunities on the
part of the taxpayers unlucky enough to get swept up in the TCMP net.

‘Taxpayer Reaction

‘Ask any taxpayer who has ever been subjected to a TCMP examination about their
experience. I had one client, a medical doctor, define it as “an autopsy without the benefit
of dying,” He had his personal income tax returns, his corporate income tax returns, his,
pension plan returns, and the retums of his children’s trusts all examined as 2 part of the
last TCMP. He is still amazed about the sheer volume of data the auditor required and the
cost of having representation throughout the process well exceeded his usual annual costs
for tax and accounting assistance. The result of his audit was that all returns were
accepted as filed. But that is scant solace for his lost income for the time away from his
practice, the months of responding to ever increasing demands for more and different


38

of unreported income to see if, in fact, the tax return is reflective
of the individual’s financial situation.

But we should not be into an area that is not related to that tax
return and is not related to verifying income or assuring that the
right amount has been reported.

Mr. ZIMMER. Would the IRS ask about noninterest bearing check-
ing accounts?

Mr. BRAND. We could, yes, sir.

Mr. ZIMMER. About gifts that the taxpayer has received?

Mr. BRAND. The way you would get into discussions in this par-
ticular area, Mr. Zimmer, would be if there were indications during
the examination that there was income in excess of what had been
reported, or there were expenditures in excess of the income that
is reported. At that particular point in time, we are trying to deter-
mine the source of that additional income. There could be a legiti-
mate source, such as gifts being received or expenditures from
gifts, or outlays that might be subject to discussion.

Because what we are trying, again, to determine is the financial
picture. Is there a reality as far as the tax return is concerned?
Does that tax return represent the financial picture of the tax-
payer?

Mr. ZIMMER. So the only questions that you ask are questions
that relate to the validity of that tax return, not to other research
objectives or data collection interests that you have?

Mr. BRAND. In terms of the research, it is related to the tax re-
turn and the financial issues involving that tax return.

Mr. ZIMMER. Well, let us say that the couple refuses to divulge
information about a noninterest bearing checking account, would
you subpoena that information?

Mr. BRAND. It would depend on the extent of what we felt other
noncompliance is. IRS has the ability to summons that but again,
I do not know what the situations are. But not with a small
income-tax payer in a situation like that, depending on what the
other circumstances were. If this largely appeared to be a compli-
ant taxpayer, I doubt we would do that, but, yes, sir, it could hap-
pen. It depends on the individual situation.

Mr. ZIMMER. But if your interest was only to develop a data base
for your research purposes——

Mr. BRAND. Well, again, I think what we may be doing is two
things. The TCMP audit is only slightly different than a regular ex-
amination. From the standpoint of the Taxpayer Compliance Meas-
urement Program examination, examiners are expected to exercise
the same judgment about the level of proof and need for informa-
tion as in a regular examination.

Mr. ZIMMER [continuing]. So for TCMP, you are only looking at—
might you have a broader scope?

Mr. BRAND. We would only broaden the scope if we felt that
there was unreported income on that particular examination. Ab-
sent unreported income, there would not be any reason for us to
go into it.

Mr. ZIMMER. All right, thank you, very much.

Chairman JOHNSON. Mr. Laughlin.

Mr. LAUGHLIN. Thank you, Madam Chairman.


125
for DIF. I think they are better in combination with something like

I do think TCMP is essential for the IRS in some form. I think
a question still remains as to how big TCMP should be. I just.
wanted to say a bit about the household component. In the past,
TCMP sampled about 50,000 households. ie proposed MP
would sample 90,000 households.

Expanding the sample would surely allow the IRS to get greater
sampling densities in certain subpopulations. It is my experience
that some population subgroups are very thin in existing TCMPs
down to say a few dozen taxpayers which can make it difficult to
determine what kind of tax audit systems to use. I do not think I
would want to reduce that very far. But I have to say that based
on what I know, I am not convinced that the substantial cost in-
volved in expanding the TCMP would be worth the benefits to be
gained, which seem to me to be uncertain.

I will say I have not seen all the evidence about that, but I am
not convinced at the moment of what the benefits would be.

Thank you for the invitation to testify, and I hope my testimony
is useful for you.

[The prepared statement follows:]


100

‘When public opinion pollsters wish to conduct a lengthy examination of public
attitudes, they rely on focus groups. In order to get people to attend focus groups they pay
them. This enables the public opinion professional to secure a representative sample of
people who are willing to give up several hours of their time to answer questions and react
to proposals.

The IRS is proposing to conduct perhaps the nation’s most tedious and expensive
focus group. But instead of the IRS paying the survey participants, the subject must
participate at no charge. Indeed most will probably pay a tax professional hundreds or
thousands of dollars for assistance with this ordeal. And don’t forget that the taxpayer may
have to fork over even more taxes or spend thousands of dollars to appeal a decision by a
tax auditor who is unfamiliar with the tax law and has recommended an incorrect claim for
additional tax.

If the IRS believes gathering this data is so important, it should pay taxpayers for
their time and expense of submitting to the audit. This will give the agency an incentive to
design a TCMP survey that efficiently considers the use of all national resources, not just
agency funds.

Reimbursement should not be based on the results of the examination; it should be
based on some multiple of the hours spent by the IRS in completing the TCMP exam
(including pre-audit, review and supervisory time). For example, for every hour spent by
the IRS, the taxpayer and representative should be reimbursed for two hours. The “rate” of
reimbursement could be based on the prevailing rate in the local area for professional
representation.

‘While some may argue that taxpayers whose exams render a sizable deficiency and
substantial non-compliance should bear the cost of their examinations, this will only serve
to encourage some at the IRS to assume overly aggressive positions with respect to
potential adjustments.

‘When originally conceived, the TCMP was likely the only method realistically
available to determine the level of taxpayer compliance that the program was designed to
assess. At the time it was initially developed and implemented, the collective resources
available to the Intemal Revenue Service to obtain the type of information with respect to
various categories of taxpayers and their varying degrees of compliance with our income
{ax laws were far more limited than the resources available today. Moreover, compliance
with the overwhelming technical and mechanical requirements of the tax law was far less.
burdensome than that faced by taxpayers today and, consequently, the time and effort — as
well as likely professional fees — were less than what faces potential TCMP targets today.

Today, the IRS has access to a wealth of information -- over a billion information
documents per year - that can lend itself to the kind of statistical analysis that is developed
by the TCMP. This includes the ability to more thoroughily analyze (both quantitatively and
Aalitatively) the results ofthe ongoing, regular examination process. And it becomes
readily apparent when one examines the characteristics, methods and objectives of the
IRS's “economic reality” audit approach.

We have previously expressed our concern about privacy issues related to the
“economic reality” examination approach. Nonetheless, the mere fact this information is
available, that the IRS has access to data bases and taxpayer information infinitely greater
than when the TCMP was conceived, should have reduced the need for an arbitrary
‘examination process as intrusive as TCMP. In addition, the IRS has and can continue to
focus on particular types of deductions or other tax information on a targeted basis. This
information is often developed by region and income level and probably provides more
significant and timely information than what results following the years of accumulation
and interpretation of TCMP results.

We also call the Committee's attention to the increased specialized knowledge that
the IRS has developed largely without use of TCMP results as evidenced by the Market
Segment Specialization and Industry Specialization Programs.

Relevance of the data obtained in TCMP is questionable.

We cannot think of a single instance since 1986 where the IRS has made a
legislative proposal based on the most recent TCMP survey. There is clearly an enormous
problem with eamed income tax credit (EITC) compliance, yet after the latest TCMP, the
IRS sent out EITC refunds to taxpayers who didn’t qualify for the program! The IRS
‘made no attempt to recover this money. EITC has also been an area rife with fraud


41

agent were to give the taxpayer the questions or the areas of in-
uiry so that they might come prepared rather than feeling like
they are going to get sandba; ed I wonder if the IRS or the GAO
has given consideration to a decision of having the agent tell the
taxpayer what the area of inquiry is going to be?
ir. BLock. Well, the auditors do that in an oblique way when
they ask taxpayers to provide various information.

Mr. LAUGHLIN. Is this preliminary to the taxpayer showing up at
the audit?

Mr. BLOCK. Yes.

Ms. STATHIS. The letter they receive informing them of the audit
should give them that information.

Mr. LAUGHLIN. The information of the areas of inquiry that the
agent intends to go into?

Ms. STATHIS. That is right.

Mr. LAUGHLIN. OK. Thank you, Madam Chairman.

Chairman JOHNSON. Thank you.

Mr. Hancock.

Mr. HANCock. Thank you, Madam Chairman.

Ms. Stathis, I notice in your testimony you say that it has taken
IRS more than 4% years to complete a TMP. am assuming that
because of the changes in the income tax law that you have got
something after you complete it. Because you are making an analy-
sis of what the law was at least 4 years ago, is that correct?

Ms. STATHIS. That is correct.

Mr. Hancock. So you have made an analysis that is already 4
years old?

Ms. STATHIS. That is right.

Mr. HANcock. So you still do not know. You just know what it
was 4 years ago?

Ms. STATHIS. That is right. Timeliness is an issue. It always is,
there is always a lag. Not only are there tax law changes, there are
other kinds of economic changes.

Mr. Hancock. So we know now then that your last compliance
report is at least 4 years old, so you do not really know what the
compliance is going to be for last year? You only know what it was
in 1990 based on the law in 1990.

Ms. StTaTHis. Right. Actually some TCMPs are a lot older than
that. The last TCMP that was done of partnerships used 1981 tax
returns. For S corporations, I believe it was 1984 returns. For
small corporations, it was 1987 returns, and for individuals it was
1988 returns.

So the data available right now is very dated.

Mr. Hancock. I just want it in the record that this is another
indication that we ought to leave the tax law alone for a while until:
people can figure out what we are doing, because we are alread
outdated even on your compliance reports. You are spending mil-
lions of dollars to make these reports, but by the time you get them
completed, it is 5 years old, so you really do not know. You just
know what it was 5 years ago. Historical data is all we are talking
about.

Ms. STATHIS. That is correct. That is why the point Mr. Block
was making is important. For the first time, if IRS is able to enter
the TCMP data in the computerized system and have it available