TAX

ADMINISTRATION

IRS Is Working to

Improve Its Estimates

of Compliance

Burden

United States General Accounting Office

GAO Report to the Chairman

Committee on Small Business

U.S. Senate

May 2000

GAO/GGD-00-11

United States General Accounting Office General Government Division

Washington, D.C. 20548

Page 1 GAO/GGD-00-11 Taxpayer’s Compliance Burden

B-283788

May 22, 2000

The Honorable Christopher S. Bond

Chairman, Committee on Small Business

United States Senate

Dear Mr. Chairman:

Taxpayers spend considerable time and money complying with the federal

income tax rules. While much of this compliance burden is attributable to

the tax code, another portion can be linked to Internal Revenue Service

(IRS) actions. Reliable estimates of the burdens imposed by such

compliance could assist Congress in reducing those burdens, and assist

IRS in developing measures of its own performance, making better

informed resource allocation decisions within the agency, and meeting

reporting requirements under the Paperwork Reduction Act. We have

reported that the estimation model that IRS currently uses for compliance

burden ignores important components of burden and has limited

capabilities for analyzing the determinants of burden.1

You asked us to report on the status of IRS’ efforts to improve its estimates

of taxpayer compliance burden. Accordingly, in this report, our objectives

were to (1) describe IRS’ overall strategy to improve its methodology for

estimating compliance burden, (2) describe what IRS has done to begin

implementing its overall strategy and how IRS expects this to improve its

methodology, and (3) determine whether IRS expects that its new

methodology will be able to measure the burden associated with the

complex tax rules identified in IRS’ forthcoming first annual report on tax

complexity.2

To improve its methodology for estimating compliance burden for all types

of federal taxpayers, IRS is pursuing a multiphased strategy. Initially, IRS

is focusing on taxpayers who have only wage and investment (W&I)

income because they bear a large portion of the overall compliance burden

and because their burden may be easiest to estimate. Later phases would

develop estimates for other taxpayer groups, such as small businesses and

the self-employed and large and medium-sized businesses. This

 1

Small Business Tax Compliance Burden (GAO/GGD-99-96R, May 5, 1999).

2

This report was mandated by the IRS Restructuring and Reform Act of 1998 (P.L. 105-206, July 22,

1998).

Results in Brief
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incremental strategy should give IRS and its contractors the flexibility to

incorporate lessons learned from early phases of the process into later

efforts.

IRS has begun to implement its strategy by contracting for the

development of two models that, when combined, should provide more

reliable estimates of W&I taxpayers’ prefiling, filing, and postfiling

compliance burdens. Compared with IRS’ current methodology, these

models are designed to produce more comprehensive estimates of federal

income tax compliance burdens and to provide IRS with a greater capacity

to analyze the impact of tax law and administrative changes on those

burdens. As with all such modeling, the specific capabilities and precision

of the new models will depend on the quality of the underlying data.

IRS expects that one of the new models, covering prefiling and filing

activities, will provide some assistance in estimating burdens associated

with the complex rules identified in IRS’ forthcoming first annual report on

tax complexity.3

 For some rules, the model may be able to show both the

number of W&I taxpayers affected and the approximate size of their

burdens. For other rules, IRS expects that the model will only be able to

show the potential number of taxpayers affected. The other model, which

is to estimate postfiling burden, is in the early design stage, and its

capabilities have not yet been determined.

IRS reviewed a draft of this report and agrees with the content.

IRS has been seeking to improve its compliance burden estimation

methodology for several reasons. First, it would like a tool to assist

policymakers in understanding the sources of burden and evaluating

options for reducing that burden. Second, IRS would like to know how its

own programs and activities affect compliance burden. This information

could be used to develop additional performance goals and measures for

reducing burden and would assist managers in targeting resources and

developing new programs. Third, the 1995 amendments to the Paperwork

Reduction Act of 1980 and the 1993 Government Performance and Results

Act (GPRA) impose new reporting requirements that IRS’ existing

methodology was not designed to meet.

 3

The IRS report will focus on the Alternative Minimum Tax (AMT) for individuals, the variety of

definitions that taxpayers must learn in order to determine their filing status and eligibility to claim

dependents and credits, and the estimated tax rules.

Background
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IRS’ current model for estimating taxpayer compliance burden, developed

by Arthur D. Little, Inc. (ADL), was considered a substantial improvement

over the agency’s previous methodology when it was first introduced in the

1980s. However, IRS and other observers have identified several significant

shortcomings of the model that limit its usefulness and accuracy. Two

important limitations of the model are that it ignores significant

components of burden, as well as important determinants of burden.4

The ADL model was designed to meet reporting requirements arising from

the Paperwork Reduction Act. Pursuant to that act, the Office of

Management and Budget (OMB) established the annual Information

Collection Budget and required federal agencies to provide estimates of

the paperwork burdens that they impose on the public.5

 The definition of

burden that the ADL model uses to meet this reporting requirement

includes the estimated time costs (burden hours) imposed by information

collections but excludes costs associated with tax planning and postfiling

activities, such as preparing for an audit. It also excludes most monetary

expenses. For example, paid preparer fees were converted into an

equivalent time amount, but expenditures on books, software, and delivery

services were excluded. Amendments to the Paperwork Reduction Act in

1995 now require IRS and other agencies to include these monetary

expenses in their burden estimates. IRS would like to use an even broader

definition of compliance burden—including the tax planning and postfiling

burdens—when developing performance measures under GPRA or when

evaluating the effects of changes in tax laws and administrative practices.

Past reviews of the ADL model have criticized the approach that it uses to

update estimates of compliance burden from year to year as simplistic.6

These reviews noted that the model does not account for changes in

important determinants of burden, such as tax preparation technology and

taxpayers’ education and experience. These shortcomings limit the

 

4

See appendix I for more detail on these and other limitations of the model.

5

The Information Collection Budget is the means by which the federal government, through OMB,

measures and controls the number of hours individuals, businesses, state and local governments, and

others must spend complying with federal reporting requirements. The Information Collection Budget

is prepared annually based upon the prior fiscal year’s experience and current estimates of the “burden

hours” imposed by individual forms, surveys, and other information collections.

6

See, e.g., IRS, “Report of the Taxpayer Burden Study Group: Roadmap for a New Measure and Pilot

Study for Individual Non-Business Taxpayers,” Request for Proposal (Aug. 19, 1998); Marsha

Blumenthal, Burden Reduction Research and Analysis, report submitted to the Analysis and Studies

Division, IRS (May 1996); and Henry Beale, untitled draft report on Arthur D. Little Compliance Burden

Model, submitted to the Analysis and Studies Division, IRS (1996).
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model’s usefulness as an analytical tool and raise concerns about the

accuracy of its estimates.

In August 1998, an IRS study group identified the type of burden estimation

model that the agency would like to have.7

 Ideally, the model would be

able to

• estimate the burden associated with all prefiling, filing, and postfiling

activities undertaken to comply with federal income, estate and gift,

employment, and excise tax rules;

• disaggregate total compliance burden by type of tax, taxpayer, and activity;

• disaggregate burden by origin of compliance requirements (tax laws,

regulations, and administrative procedures);

• estimate changes in burden associated with potential tax law changes;

• function in an integrated manner, allowing users to see how certain tax

changes affect multiple taxpayer groups;

• disaggregate burden by IRS function (e.g., submission processing and

customer service) for burdens associated with the requirements of, and

taxpayer interactions with, those functions;

• estimate the impact on taxpayer burden of alternative enforcement

programs and techniques providing customer service;

• provide different types of estimates for different purposes (e.g., the

estimates required for the Information Collection Budget are different

from those that IRS would use for performance measurement under

GPRA);

• estimate burden in terms of dollars as well as time; and

• incorporate new data with sufficient ease so that the model, itself, would

not have to be replaced in the near future.

To address the first two objectives of this report we interviewed IRS

officials about their ongoing and planned efforts to develop new burden

estimation methodologies. We also reviewed extensive documentation

prepared by IRS' contractor PricewaterhouseCoopers (PwC), which

described (1) the objectives of the new compliance burden estimation

models; (2) the conceptual and operational designs of the model covering

prefiling and filing burdens and the conceptual design of the model for

postfiing burdens; and (3) research that PwC completed to inform its

design decisions. We did not evaluate the effectiveness or appropriateness

of the designs for the new models. We also reviewed documentation

relating to the ADL model, as well as existing evaluations of that model by

 

7

IRS, “Report of the Taxpayer Burden Study Group.”

Scope and

Methodology
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IRS and external analysts, in order to identify differences between that

model and the new models.

To address the third objective we obtained information from IRS about the

expected content of their forthcoming complexity report. We reviewed

PwC's description of how it expects the new prefiling/filing burden model

will operate and inferred how that model could be used to estimate the

burden associated with certain aspects of the tax rules discussed in IRS'

report. We confirmed with IRS officials that our understanding of how the

model could be used with respect to these complex rules was consistent

with IRS' expectations of the model's capabilities.

We conducted our review from July 1999 through April 2000 in accordance

with generally accepted government auditing standards. We requested

comments on a draft of this report from the Commissioner of IRS. His

comments are discussed near the end of this letter and are reproduced in

appendix III.

To accomplish its goal of improving its methodology for estimating

compliance burden for all types of federal taxpayers, IRS is pursuing a

multiphased strategy. Initially, IRS is focusing on taxpayers who have only

W&I income. Later phases would develop estimates for other taxpayer

groups, such as small businesses and the self-employed and large and

medium-sized businesses.

IRS’ incremental approach is intended to mitigate the risks associated with

developing a new methodology for estimating compliance burden. The

approach should give IRS and its contractors an opportunity to

incorporate lessons learned from early phases of the process into later

efforts. It also should give IRS the flexibility to significantly modify or

terminate the overall development process or its relationship with a

particular contractor. IRS’ Office of Program Evaluation and Risk Analysis

is responsible for overseeing the contractor’s work.

The first phase of the development process focuses on the design and

implementation of models for estimating the federal income tax

compliance burden of W&I taxpayers—those that derive all of their

income from wages, pensions, interest, dividends, and capital gains. This

taxpayer group was selected for the initial phase because it accounts for a

large share of IRS’ overall compliance burden and because its burden may

be the easiest to estimate. The conceptual definition of compliance burden

developed for this group, along with the theoretical framework for

IRS Is Pursuing a

Multiphased Approach

in Developing New

Burden Estimation

Methods
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measuring that burden, are intended to build a foundation for developing

burden estimates for other taxpayer groups.

In subsequent phases, estimation methodologies are to be developed for

other segments of the taxpayer population, such as small businesses and

self-employed taxpayers and large and medium-sized businesses. The

timing of these later phases will depend on resource availability and the

accumulation of experience. IRS expects to contract out later this year for

a study that would develop a methodology for estimating the time and

money that self-employed individuals spend preparing and filing their

federal income tax returns. The agency also expects to begin work on

employment taxes later this year and on small corporate taxpayer burden

in calendar year 2001.

IRS has begun to implement its strategy by contracting for the

development of two models that, when combined, are to estimate W&I

taxpayers’ prefiling, filing, and postfiling compliance burdens. Compared

with IRS’ current methodology, these models are designed to produce

more comprehensive estimates of federal income tax compliance burdens

and to provide IRS with a greater capacity to analyze the impact of tax law

and administrative changes on those burdens. As with all such modeling,

the specific capabilities and precision of the new models will depend on

the quality of the underlying data.

PricewaterhouseCoopers, the contractor engaged to assist IRS in the initial

phase of its strategy, has begun to develop two models covering W&I

taxpayers—one for estimating the prefiling and filing burdens, the other

for estimating the postfiling burdens of those taxpayers. This work began

in September 1998. The model for estimating prefiling and filing burdens is

expected to be delivered to IRS in May 2001. The postfiling burden model

also is expected to be designed by then, but the operational model is to be

delivered at a later date. Before delivering either model, PwC is to provide

IRS with paperwork burden estimates for this taxpayer group, using the

new methodology, for the agency’s Information Collection Budget due in

December 2000. The cumulative cost of this initial effort is expected to

reach approximately $5 million by the end of fiscal year 2001.

Expenditures for later years have not yet been determined.

New Estimation

Models for W&I

Taxpayers Are in

Development

IRS’ Contractor Has Begun

Developing Two Models
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The two models are intended to produce more comprehensive estimates of

burden by including all of the time costs covered by the ADL model, plus

time spent on tax planning and postfiling activities. They are also to

estimate the monetary expenditures associated with federal income tax

compliance, such as the purchase of books and software, which are not

covered by the ADL model.8

PwC said it used focus groups of taxpayers and tax preparers to identify a

lengthy list of activities and costs involved in the prefiling and filing stages

of the tax compliance process. It has grouped these activities and costs

into six broad categories: recordkeeping, gathering tax materials, using

IRS services, tax planning, form completion, and form submission. The

initial plan for the postfiling burden model is also to group activities and

burdens into six categories: recordkeeping and retrieval, gathering tax

materials, using IRS services, form completion and form submission, using

a paid professional, and interviewing.9

The definition of compliance burden for both models excludes any

activities or costs associated with

• the basic financial planning and recordkeeping that individuals might do

even if there were no income tax,

• requirements imposed by federal taxes other than the income tax,

• requirements imposed by state or local taxes,

• criminal tax investigations, and

• Tax Court proceedings.

According to PwC, its models will not distinguish between “required” and

“voluntary” compliance activities because there is no clear benchmark of

“required” activities against which to measure “voluntary” tax minimizing

activities. PwC noted that, although the expenditure of time and money

spent on tax minimizing activities, such as itemizing deductions, is

voluntary,10 some taxpayers would incur the cost of higher taxes if they did

not make those expenditures.

 

8

Neither of the new models is to estimate the costs of employers, banks, and other third parties that

are required to provide information returns to individual taxpayers. Those costs are to be included

when the total tax compliance costs of those entities are estimated at a later date.

9

Even though some of the category names are the same for the two models, the activities covered by

the two models do not overlap. For the postfiling model, e.g., “form completion and submission” covers

only submissions that may have to be made after the initial filing of the taxpayer’s return.

10Taxpayers have the option of claiming the standard deduction, which is less burdensome than

itemizing.

The New Models Are

Intended to Produce More

Comprehensive Estimates

of Burden
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The two new estimation models are intended to provide IRS with

increased capabilities to analyze burden, disaggregated by type of taxpayer

activity. In addition, the prefiling/filing burden model, which is further

along in development, is intended to enable IRS to analyze the effects of

changes in tax laws, IRS programs and services, and other important

determinants of burden.

PwC determined that, to meet IRS’ analytical requirements, its

prefiling/filing burden model would have to take into account the

influences of many significant determinants of burden that the ADL model

ignores. PwC said it relied on its focus groups of taxpayers and interviews

with tax preparers to identify important determinants of burden and to

gain a better understanding of the complex relationships between these

determinants and burden. The insights obtained through the focus groups

and interviews have guided PwC’s model design, data gathering, and model

construction efforts.

PwC conceives the tax compliance process as a series of decisions made

by taxpayers that result in a variety of activities, each of which imposes

some burden. For example, a taxpayer incurs additional recordkeeping

and reporting burdens if he or she chooses to itemize deductions from

income, rather than claim the standard deduction. These taxpayer

decisions and activities are influenced by such factors as tax system

characteristics (e.g., specific recordkeeping and reporting requirements),

demographic characteristics (e.g., age, income, and tax-filing experience of

individual taxpayers), and others (e.g., tax preparation and filing

technologies).

One important insight from the focus groups was that, in most cases, the

activities a taxpayer engages in change little from year to year. Another

important insight was that the most significant changes in compliance

activities are due to life changes (e.g., marriage or birth of dependents),

changes in financial situation (e.g., the purchase of a house), and changes

in the tax code. According to PwC, changes in these factors have

particularly significant effects on compliance burden when they lead

taxpayers to change their basic approach to tax preparation. This is due to

the fact that the types of activities taxpayers engage in vary significantly,

depending on whether they prepare their return by hand, use tax

preparation computer software, or hire a professional to prepare their tax

return. PwC also determined that the more experience taxpayers gain in

filling out returns, the less of a burden it becomes. PwC expects that

models that account for these determinants of burden will provide IRS

with analytical capabilities it does not possess now.

The New Models Are Also

Intended to Provide IRS

With Increased Analytical

Capabilities
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There are three phases in the construction and operation of the

prefiling/filing burden model, all of which must be successfully completed

for IRS to realize the increased analytical capabilities it is seeking. First,

data must be collected that describe taxpayer characteristics, decisions,

activities, and burdens. Second, statistical techniques must be used to

estimate the relationships between key outcomes, such as taxpayer

decisions and compliance burden levels, and their determinants. Finally,

the estimated relationships must be applied to data from a representative

sample of taxpayers in order to simulate taxpayer decisions and the

resulting level of burden.

PwC intends to meet many of its data requirements by relying upon

existing IRS administrative and research data files. It also hopes to make

use of demographic and personal finance data that the Census Bureau and

other government agencies collect from samples of households. However,

PwC and IRS have decided that they need to survey a representative

sample of taxpayers in order to collect information on the compliance

burdens those taxpayers incur. Each telephone interview is expected to

cover up to 92 questions and last approximately 20 minutes, depending on

the characteristics of the respondent. Data from this survey are to be

directly merged with data from IRS’ computer files for these same

taxpayers. In addition, statistical imputation techniques11 are to be used to

supplement the data record for each taxpayer with information that is not

available from IRS files (such as information on the taxpayer’s educational

background and spending behavior).

The data collection and analysis tasks that PwC must accomplish are

ambitious for several reasons. First, the taxpayers surveyed by PwC will be

relying on their memories to estimate the amounts of time and money they

spent preparing their 1999 tax returns. Second, for each of these taxpayers,

PwC will have to be able to collect or impute accurate data on the

numerous determinants of their compliance burdens, including the specific

tax rules that apply to them. Third, PwC will have to estimate statistical

equations that accurately isolate the individual effect that specific tax rules

have on the compliance burdens of specific types of W&I taxpayers. While

the data collection and analysis tasks are ambitious, PwC believes that the

 

11Imputation techniques are commonly used to combine data from separate sources when it is not

possible to use a common identifier, such as a Social Security Number, to ensure that the data being

linked from each source pertain to the same individual. One could use, e.g., detailed data from a survey

to estimate a regression equation showing the relationship between variables, such as income and area

of residence on the one hand, and level of education on the other. With the estimate of this

relationship, one could then “impute” the level of education of individuals represented in a different

database, as long as the second database contained data on income and area of residence.

Realizing the Increased

Capabilities Depends on

Complicated Data

Collection and Analysis

Data Collection Will Be

Challenging
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Page 10 GAO/GGD-00-11 Taxpayer’s Compliance Burden

available data will enable it to estimate equations that improve upon IRS’

current methodology.

The data most critical to the modeling effort—those relating to the time

and money that taxpayers spend complying with tax rules—are subject to

measurement error of an unknown degree. The accuracy of the burden

data that PwC collects in its survey will depend, in part, on each

respondent’s ability to understand the definition of burden used in the

model. PwC recognizes that there are limits to the amount of guidance it

can provide to respondents during a survey.12 For example, it does not

intend to provide guidance on how to separate the travel time attributable

to purchasing tax software from the time attributable to other errands

completed during a multipurpose shopping trip. Individual respondents

will decide for themselves whether all, or only a portion, of the time spent

on the trip should be considered a burden.

The accuracy of the burden data that PwC collects will also be limited by

recall bias on the part of respondents. The focus groups that PwC

conducted reconfirmed findings from earlier focus groups conducted by

ADL that taxpayers are not able to recall the amount of time they spent on

tax compliance very accurately. ADL provided further evidence of this

problem when it used two different methods to collect burden estimates

from taxpayers—a mail survey and a diary study (in which taxpayers kept

logs of their activities as they prepared their returns). On average,

compliance time estimates made by respondents to ADL’s mail survey

were 78 percent greater than the estimates made by participants in its

diary study (see app. I). PwC recommended a telephone survey for

collecting its burden data because that approach usually yields a higher

response rate than a mail survey and allows interviewers to clarify

questions. However, PwC acknowledges that telephone surveys do not

permit taxpayers to consult documents when responding and that

respondents’ recall may not be as accurate as in a diary study.13

The accuracy of the model’s underlying data for several important

determinants of burden, such as taxpayers’ education level and experience

in completing returns, will depend on the precision of PwC’s imputation

techniques. Although PwC intends to collect information on some of these

 

12PwC has drafted a questionnaire to be used in a telephone and mail survey of taxpayers. Appendix II

summarizes the instructions from that questionnaire.

13PwC intends to send an advance letter to respondents, telling them the general nature of the questions

they will be asked. PwC also intends to mail a written version of the questionnaire to taxpayers for

whom they cannot find telephone numbers.
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Page 11 GAO/GGD-00-11 Taxpayer’s Compliance Burden

determinants in its taxpayer survey, it will have to impute values for them

in the model’s production file that is to be updated each year.

IRS and PwC recognize the limitations of the data on burden and its

determinants that will be used in the model. They have concluded that

their plans represent a cost-effective approach for collecting the data

needed to improve IRS’ burden estimation methodology.

Once this initial database is constructed, PwC plans to use statistical

techniques to estimate equations that describe the important relationships

needed for making simulations. One set of equations is to show how the

decisions that each taxpayer makes during the tax compliance process are

related to specific factors, such as that taxpayer’s age and education, the

particular forms that the taxpayer must complete, and the costs of

alternative preparation methods. Another set of equations is to show how

the amount of burden that a taxpayer bears is related to specific

characteristics of that taxpayer and the particular compliance

requirements that the taxpayer faces. These relationships are to be

estimated separately for each of the six categories of burden

(recordkeeping, form completion, etc.).

If the estimation efforts are successful, the relationships described in both

sets of equations should enable IRS to regularly update its model using

data on taxpayer characteristics that it already collects every year (or that

can be imputed from other available sources). IRS should not need to

collect new data on burden for each update of this “production” data file.14

To estimate the aggregate prefiling and filing compliance burden for tax

years after 1999, IRS will need to update the model’s data file to reflect

changes in the taxpayer population and enter information about any tax

law changes made since 1999. The model is to then process this

information in several stages. First, it is to simulate the effect that the law

changes have on the compliance requirements faced by each taxpayer

represented in the data file. Second, the model is to simulate taxpayer

decisions to determine if the changes in the tax laws, or changes in

taxpayers’ circumstances from one year to the next, would cause any of

 

14The core of the production data file is to consist of detailed data that IRS’ Statistics of Income

Division collects annually from a large sample of individual tax returns.

Numerous Equations Describing

Taxpayers’ Decisions and

Burden Must Be Estimated
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the taxpayers to change their preparation or submission methods.15 Finally,

the model is to take this updated information on tax requirements and

compliance methods for each taxpayer and, by applying the relationships

from the previously estimated equations, estimate the time and money that

each taxpayer spent on each of the six categories of burden activities.16

While IRS expects the new prefiling/filing burden model to improve its

burden estimation capabilities, the model, by itself, will not provide all of

the capabilities that IRS was originally seeking. It will not disaggregate

burden by specific IRS function (e.g., submission processing and customer

service), nor will it disaggregate burden by origin of compliance

requirement (tax law vs. administrative procedure). The model is supposed

to be able to accommodate these capabilities at a future date, but it will be

up to IRS to determine how these disaggregations would be done.

In addition, PwC is not expected to statistically estimate the effect that

each and every tax rule has on the average burdens of W&I taxpayers.

However, even in cases where PwC has not statistically estimated the

average burden of a particular tax rule, the model may be able to identify

how many and what types of W&I taxpayers are affected by the rule. IRS

could then use some independent method, such as a targeted research

project, to estimate the change in the average amount of burden that a

specific change in the tax rule would cause. By combining this estimate

with the information on the number of taxpayers affected, IRS would be

able to estimate the aggregate burden change that would result from the

tax rule change. At this time, PwC does not know for how many, or which,

tax rules it will be able to make specific statistical estimates.

 

15Although the model is to simulate changes in compliance-related behavior, as currently designed, it

would not, by itself, simulate other types of behavioral changes that affect aggregate burden. For

example, it would not simulate how an increase in documentation requirements for charitable

contributions would affect the number of taxpayers who claim deductions for such contributions. The

model, however, is to allow users to make “off-model” estimates of those behavioral changes and then

adjust the data in the model to capture the effects of such changes.

16If appropriate data become available, the model would have the capability to translate time spent by

taxpayers into a monetary cost. The methodology for monetizing taxpayer time is to be based on

forthcoming guidance from OMB. A PwC subcontractor has drafted a “white paper” on monetizing

compliance burden that summarizes existing research and identifies best practices. OMB is to review

that paper before developing its guidance. OMB has also solicited input to its guidance from the

broader public.

The Prefiling/Filing Burden

Model, by Itself, Will Not

Provide Everything IRS Was

Seeking
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The primary functional requirements of the postfiling burden model are

the ability to

• estimate the change in burden due to changing factors, such as the number

of audits IRS undertakes;

• disaggregate burden estimates by postfiling segment17 and by taxpayer

activity; and

• link to the prefiling/filing burden model.

Fundamental decisions remain to be made regarding the operational

design of the postfiling model. A report that presents PwC’s broad

conceptual design for the model notes that PwC and IRS need to agree on

specific interpretations of the general requirements that were set by the

contract’s scope of work. The report also indicates that the ultimate

functionality of the model may be constrained by the limitations of IRS’

data systems. For example, IRS has no database that tracks the activities

of individual taxpayers throughout the entire postfiling process. This may

prevent the model from determining if the burdens that taxpayers

experience in one segment of the postfiling process are influenced by their

experiences in a preceding segment.

The prefiling/filing burden model may assist IRS in estimating burdens

associated with some aspects of the complex rules identified in IRS’

forthcoming report on tax complexity. That report will devote detailed

attention to three areas of concern for W&I taxpayers: the Alternative

Minimum Tax for individuals, the variety of definitions that taxpayers must

learn in order to determine filing status and eligibility to claim dependents

and credits, and the estimated tax rules.18 The data that the contractor

plans to collect for the prefiling/filing burden model will provide it with the

opportunity to directly estimate the burdens associated with some, but not

all, aspects of those complex rules. IRS has not yet decided whether the

postfiling model should have any ability to estimate burdens associated

with specific tax rules.

The current list of variables that PwC intends to incorporate in its

statistical equations includes many that relate to the complex tax rules

 

17PwC proposes to divide the postfiling process into five segments: clarification (relating to IRS

requests for further information), collection, audit, appeals, and amendment (relating to the filing of

amended returns).

18IRS selected these three areas after reviewing over 40 reports and testimonies published since 1989

and meeting with both internal and external stakeholders interested in tax complexity/simplification.

Fundamental Decisions on

the Design of the Postfiling

Model Remain to Be Made

The New Models Could

Assist IRS in

Estimating the

Burdens Associated

With Some Aspects of

Complex Tax Rules
B-283788

Page 14 GAO/GGD-00-11 Taxpayer’s Compliance Burden

covered in the Commissioner’s report. Among these are variables that

indicate19

• whether taxpayers spent any time dealing with the AMT form, even if they

ultimately did not have to submit it;

• whether taxpayers who did file the AMT form filled in selected lines on

that form;

• which filing status, dependents, and credits taxpayers actually claimed;

and

• whether taxpayers paid estimated taxes and estimated tax penalties.

The availability of data for these variables may enable PwC to make

estimates, such as the average amount of time that the existence of the

AMT adds to the total compliance time of different groups of W&I

taxpayers. In those cases where PwC is able to estimate average burden

effects, the model should be able to use that information, along with

information on the number of taxpayers affected by the tax rules in

question, to estimate the aggregate burdens attributable to those rule.

However, as previously noted, PwC is not expected to directly estimate the

average burden effect of every aspect of these complex tax rules. For some

rules, IRS expects that the model will only be able to show the number of

taxpayers affected.

We received written comments from the Commissioner of IRS in a letter

dated May 3, 2000. In his letter, the Commissioner agreed with the contents

of our report and emphasized two points that we had mentioned: (1) in

contrast to the ADL model, the new model will incorporate tax preparation

method as a key determinant of burden, and (2) IRS expects to be able to

keep the new model up to date without unduly burdening itself or

taxpayers.

In addition to the written comments, IRS provided technical comments on

the report, which we incorporated where appropriate. The Commissioner’s

letter is reproduced in appendix III.

As agreed with your office, unless you announce its contents earlier, we

plan no further distribution of this report until 30 days from the date of this

letter. We will then send copies to Senator William V. Roth, Jr., Chairman,

and Senator Daniel P. Moynihan, Ranking Minority Member, Senate

Committee on Finance; Senator John F. Kerry, Ranking Minority Member,

 

19PwC notes that its list of variables is “dynamic” and that some will be dropped and new ones added as

the development of the model proceeds.

Agency Comments and

Our Evaluation
B-283788

Page 15 GAO/GGD-00-11 Taxpayer’s Compliance Burden

Committee on Small Business; Representative Bill Archer, Chairman, and

Representative Charles B. Rangel, Ranking Minority Member, House

Committee on Ways and Means; the Honorable Lawrence H. Summers,

Secretary of the Treasury; the Honorable Charles O. Rossotti,

Commissioner of Internal Revenue; and the Honorable Jacob J. Lew,

Director, Office of Management and Budget. We will also make copies

available to others on request.

Please contact me or James A. Wozny at (202) 512-9110 if you have any

questions. Marvin G. McGill and Margarita Vallazza made key contributions

to this report.

Sincerely yours,

James R. White

Director, Tax Policy and

 Administration Issues
Page 16 GAO/GGD-00-11 Taxpayer’s Compliance Burden

Contents

Letter 1

Appendix I

Limitations of the

Arthur D. Little Model

18

Appendix II

Details on the

Definition of Burden to

Be Used in the PwC

Survey

20

Appendix III

Comments From the

Internal Revenue

Service

24

Abbreviations

ADL Arthur D. Little, Inc.

AMT Alternative Minimum Tax

GPRA Government Performance and Results Act of 1993

IRS Internal Revenue Service

OMB Office of Management and Budget

PwC PricewaterhouseCoopers

W&I Wage and investment income
Page 17 GAO/GGD-00-11 Taxpayer’s Compliance Burden
Appendix I

Limitations of the Arthur D. Little Model

Page 18 GAO/GGD-00-11 Taxpayer’s Compliance Burden

To measure the paperwork dimension of compliance burden, IRS

sponsored a study in 1984 that has been the basis of its burden estimation

methodology since that time. Arthur D. Little, Inc. (ADL), an IRS

contractor, released the results of the paperwork burden study in 1988.

Since then, IRS and other reviewers of ADL’s paperwork burden

estimation model have criticized it for number of reasons.1 The reported

limitations of the model and its estimates can be categorized into four

areas: (1) the age of the underlying survey data, (2) the exclusion of certain

components of burden, (3) the model’s simplistic treatment of the

determinants of burden, and (4) the questionable statistical validity and

poor documentation of the estimates.

Several reviewers of the ADL model, including IRS, have criticized the age

of the burden model’s survey data. They have observed that the survey

data reflect 1983 information and lack relevance to today’s tax

environment because of the many significant changes in tax law and tax

preparation technologies that have taken place since then.

Reviewers have also expressed concern over the accuracy of the burden

estimates taxpayers provided when they were surveyed. To obtain the

information about burden, ADL used two collection methods—a mail and a

diary study. The burden estimates yielded by the two methods varied

significantly. On average, diary respondents’ estimated burden, by return,

was 8.32 hours, while mail survey respondents’ estimated burden was

14.82 hours—78 percent higher. ADL could not determine which estimate

was more accurate, so it decided to use the average of the two estimates.2

Past reviewers have noted that the definition of burden used in the ADL

model excludes important components of burden. The ADL model does

includes the time costs (burden hours) imposed by information collections

but excludes costs associated with tax planning and postfiling activities,

such as preparing for an audit. It also excludes most monetary expenses.

For example, paid preparer fees are converted into an equivalent time

 

1

IRS, “Report of the Taxpayer Burden Study Group: Roadmap for a New Measure and Pilot Study for

Individual Non-Business Taxpayers,” Request for Proposal (Aug. 19, 1998); Henry Beale, Report on

Arthur D. Little Taxpayer Compliance Burden Model, untitled draft report submitted to the Analysis

and Studies Division, IRS (1996); Marsha Blumenthal, Burden Reduction Research and Analysis, Report

submitted to the Analysis and Studies Division, IRS (May 1996); PricewaterhouseCoopers, Compliance

Burden Literature Review, draft report submitted to IRS (June 16, 1999).

2

ADL made this correction by multiplying the burden estimates that would have been obtained if it had

relied exclusively on the mail survey results by 0.78. The corrected estimate equals the average of the

two estimates that would have been obtained by using the diary results and the mail survey results

separately.

IRS and Other

Reviewers Have

Identified a Number of

Limitations

Underlying Data Are

Outdated

Certain Components of

Burden Are Excluded
Appendix I

Limitations of the Arthur D. Little Model

Page 19 GAO/GGD-00-11 Taxpayer’s Compliance Burden

amount, but expenditures on books, software, and delivery services are

excluded.

The ADL model has been criticized for the simplistic nature of the

equations it uses to represent the relationship between burden and its

determinants. In its report, ADL acknowledged the simplicity of its

equations but explained that IRS decided it would be operationally

infeasible to use more detailed and precise models.

One past reviewer noted that the only determinants of burden used in the

final model were measures of return size (numbers of forms and

attachments), form size (number of words or number of line items), the

number of references to the tax code in forms and instructions, and the

number of line items requiring records.3

 As a consequence, many important

determinants were omitted from the model. For example, the model does

not allow for alternative filing methods, such as electronic filing software

programs, and it also does not differentiate levels of burden between

simple and complex types of forms. The model does not differentiate

burden between simple and complex line items on a form, and it does not

separate burden within the form and identify parts of the form that

represent the greatest burden. In some cases the model erroneously

estimates the impact of efforts to simplify forms, instructions, or

procedures. For instance, if new lines are added to a form’s worksheet to

simplify computations, the ADL model reports an increase in burden.

Reviewers have also called into question the statistical validity of the

model. IRS indicates that errors were made in the sample weighting

techniques. In addition, the model’s methodology was poorly documented.

IRS noted that the ADL burden estimates are inconsistent because they

yield results that assign unrealistically high levels of burden to certain

forms (e.g., Form 4789, Currency Transaction Report, and Form 8300,

Report of Cash Payments Over $10,000 Received in a Trade or Business).

At the same time, IRS noted that the ADL burden estimates for many other

forms did not include the amount of time taken to mail them, even though

those forms had to be mailed to IRS. Researchers have also questioned the

validity of the business burden estimates because the ADL model yields an

estimate of burden greater than that found in the survey data on which the

model is based.

 

3

Beale, Report on Arthur D. Little Taxpayer Compliance Burden Model.

The Determinants of

Burden Are Simplistically

Incorporated

The Statistical Validity of

the Model Has Been

Questioned
Appendix II

Details on the Definition of Burden to Be

Used in the PwC Survey

Page 20 GAO/GGD-00-11 Taxpayer’s Compliance Burden

PwC has drafted the questionnaire that it plans to use to gather

information on prefiling and filing from a sample of wage and investment

taxpayers. This appendix summarizes the parts of the questionnaire that

instruct respondents on the types of costs to include in their estimates of

compliance burden and ask respondents to estimate the specific

components of their burden. The full draft questionnaire includes over 90

questions. In addition to the questions listed below, the questionnaire asks

respondents for selective demographic information that is not available

from IRS files and information on tax preparation practices. Additional

questions are designed, in part, to prompt respondents’ memories about

other activities that they may have undertaken in preparing their tax

returns.1

The recordkeeping category includes maintaining documents needed as

proof of income or expenses for federal income tax purposes. Relevant

documents include receipts, W-2 forms, and 1099 statements of interest or

dividends. Time and money spent balancing checkbooks, paying bills, or

keeping records for state or local tax purposes are not to be included. The

draft questions include the following:

• How much time did you personally spend on recordkeeping activities

related to your 1999 federal income tax return? Include

• Time spent retrieving and organizing your records in preparation for

 completing your return.

• All the time spent on activities you did related to your federal income

 tax return even if you also needed the information for other purposes.

• How much time, if any, did your spouse, relatives, or friends spend in

assisting you with these recordkeeping activities?

• How much money, if any, did you spend on these recordkeeping activities?

Include

• Expenses such as overnight delivery fees, appraisal costs, and faxing

 or copying fees.

Do not include

• The cost of any accounting software, such as Quicken, unless you use it

only for federal income tax record keeping purposes.

• Any costs associated with helping someone else.

 1

Examples of such questions are: “Did you maintain any documentation related to the household

employee tax?” and “Did you attend any classes, seminars, or workshops primarily to complete your

tax return last year?”

Draft Questionnaire on

Prefiling/Filing Burden

Recordkeeping
Appendix II

Details on the Definition of Burden to Be Used in the PwC Survey

Page 21 GAO/GGD-00-11 Taxpayer’s Compliance Burden

The gathering tax materials category covers time and money spent

gathering materials needed to complete the taxpayer’s federal income tax

return or for tax planning purposes. These materials may include any tax

forms, tax-related publications, books, or guides collected from IRS or

other sources and tax preparation software or 1999 upgrade. Some of the

draft questions are the following:

• How much time did you spend gathering the materials we just discussed?

• How much time, if any, did your spouse, relatives, or friends spend in

gathering your materials?

• How much money, if any, did you spend obtaining the materials we just

discussed?

The using IRS services category covers the time and money spent using

services, such as the Toll-Free Tax Assistance telephone line, Walk-in

Customer Assistance site, Volunteer Income Tax Assistance site, Tax

Counseling for the Elderly, IRS Web site, or Tele-Tax Telephone line. Some

questions for taxpayers include the following:

• In total, how much time did you spend using these IRS services, including

the time reaching an assistor, being put on hold, waiting, and using these

services?

• How much time, if any, did your spouse, relatives, or friends spend using

these IRS services related to your return, including the time reaching an

assistor, being put on hold, waiting, and using these services?

• Of the [time amount], how much time was spent actually using the service

after waiting to see someone or holding on the telephone?

• How much money, if any, did you spend, using these IRS services?

The paid professional category covers time and money spent by taxpayers

when consulting with professionals for tax planning purposes or to

prepare and complete their tax returns, including the time spent finding

and selecting the professional. It does not include time spent obtaining

general investment advice that was not directly related to the taxpayer’s

federal income tax; nor does it include costs for consulting on someone

else’s behalf. The category includes the professionals’ fees for consultation

and services, such as overnight delivery fees, appraisal costs, and faxing

and copying. Some draft and survey questions are the following:

• How much time did you spend consulting with paid professionals?

• How much time, if any, did your spouse, relatives, or friends spend

consulting with paid professionals about your federal income taxes?

• How much did you pay the professionals with whom you consulted?

Gathering Tax Materials

Using IRS Services

Paid Professionals
Appendix II

Details on the Definition of Burden to Be Used in the PwC Survey

Page 22 GAO/GGD-00-11 Taxpayer’s Compliance Burden

• Was any of the [dollar amount] paid in order to file your return

electronically?

• How much did you spend to file your return electronically?

• Was any of the [dollar amount] paid in order to receive an accelerated or

instant refund?

• How much did you spend to get an accelerated refund?

• Was any of the [dollar amount] paid in order to complete your state or

local tax return?

• How much did you spend to get the state or local tax return completed?

The tax planning category covers the time and money spent considering

the federal income tax implications of activities, such as contributing to an

Individual Retirement Account, including withdrawals and distributions;

participating in a 401(k) plan or other employer-sponsored retirement

plan; taking advantage of tax-exempt or tax-preferred investments;

realizing capital gains or capital losses on any investments; exercising

stock options; and planning charitable contributions. A few of the draft

questions are the following:

• How much time did you spend on federal income tax planning activities?

• How much time (in hours or minutes), if any, did your spouse, relatives, or

friends spend in activities related to federal income tax planning for your

federal income taxes?

• How much money, if any, did you spend on these activities, including the

cost of classes, seminars, or workshops attended for tax planning

purposes? Do not include the costs of a paid professional or costs related

to tax planning for someone else.

The form completion category covers the time and money spent

completing forms, whether they were submitted or not; consulting

instructions, publications, or other materials while filling out forms; or

completing your federal income tax and related returns. It also includes

the time reviewing and checking the returns no matter how they were

prepared and completing nonreturn forms such as the W-4 and 1040ES.

The category may also include the time spent filing for an extension or

installing or updating tax preparation software.

The form completion category does not include time submitting the

returns; preparing state, local, or someone else’s tax returns; or

recordkeeping. It also does not include the costs of a paid professional or

costs related to completing someone else’s return. Draft questions include

the following:

Tax Planning

Form Completion
Appendix II

Details on the Definition of Burden to Be Used in the PwC Survey

Page 23 GAO/GGD-00-11 Taxpayer’s Compliance Burden

• How much time did you spend completing your 1999 federal income tax

return?

• How much time if any, did your spouse, relatives, or friends spend

completing your 1999 federal income tax return?

• How much time did you spend on forms or worksheets that you did not

submit?

• How much money, if any, did you spend to complete your 1999 federal

income tax return?

The form submission category may include photocopying and mailing

charges and cost of electronic filing, including service fees. Draft

questions include the following:

• How long did it take you, your spouse, relatives, or friends to submit your

return [and complete the form 8453], including the time spent

photocopying and assembling your return?

• How much money did you spend to submit your return?

Form Submission
Appendix III

Comments From the Internal Revenue Service

Page 24 GAO/GGD-00-11 Taxpayer’s Compliance Burden
Appendix III

Comments From the Internal Revenue Service

Page 25 GAO/GGD-00-11 Taxpayer’s Compliance Burden
Page 26 GAO/GGD-00-11 Taxpayer’s Compliance Burden
Page 27 GAO/GGD-00-11 Taxpayer’s Compliance Burden
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