United States General Accounting Office

GAO Report to the Joint Committee on

Taxation

July 1997 TAX POLICY AND

ADMINISTRATION

1996 Annual Report on

GAO’s Tax-Related

Work

GAO/GGD-97-122

GAO United States

General Accounting Office

Washington, D.C. 20548

General Government Division

B-277179 

July 1, 1997

The Honorable Bill Archer

Chairman

The Honorable William V. Roth, Jr.

Vice Chairman

Joint Committee on Taxation

Over the years, the General Accounting Office has provided Congress, the

executive branch, and the public with detailed information on and

objective analyses of the nation’s tax system. As part of our responsibility,

we have studied both the revenue side of the budget—tax receipts that

finance federal government operations and tax expenditures that promote

numerous social and economic objectives—and the federal agency that

administers the tax code, the Internal Revenue Service (IRS).

Some of our reports and testimonies have addressed how IRS collects

delinquent taxes, responds to taxpayers’ inquiries, and plans to modernize

its operations to improve productivity and better manage its finances.

Other reports and testimonies have described how tax system reforms and

the growth of tax expenditures affect IRS’ operations and taxpayers’

compliance burden. Still others have discussed ways to narrow the gap

between the amount of outstanding taxes owed by individuals and

businesses and the money IRS collects.

This report summarizes the studies we issued during fiscal year 1996 to

Congress and IRS and the statements we made before Congress and the

National Commission on Restructuring the Internal Revenue Service. For

the year, we published 50 reports under 6 broad areas:

• IRS management and budget,

• individual and business tax issues,

• customer service,

• submission processing,

• accounts receivable/collections, and

• tax expenditures and preferences.

The following pages highlight notable reports and testimonies from these

areas. Appendix I summarizes all of our fiscal year 1996 products, and

appendix II lists them chronologically.

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B-277179 

IRS Management and

Budget

IRS is in the midst of reorganizing and reengineering its major

technological, organizational, operational, and financial processes.

Through its reengineering efforts and Tax Systems Modernization (TSM)

program, IRS plans to introduce new technology to support these and other

changes directed toward making it a more efficient organization. However,

as a result of tighter budgets and increasing congressional concern over

the pace of its modernization, IRS is rethinking its business vision and

rescoping its planned changes.

Tax Systems Modernization: Progress in Achieving IRS’ Business Vision

(GAO/T-GGD-96-123, May 9, 1996). In hearings before the Senate Governmental

Affairs Committee, we described IRS’ progress toward achieving its vision

for improving its operations by the year 2001 and its plans for using TSM in

support of that vision. IRS’ vision calls for organizational, technological,

and operational changes in processing tax returns, providing customer

service, and ensuring compliance with tax laws. IRS has made some

progress in modernizing its operations but still falls far short of its vision.

One of the biggest problems facing IRS has been its inefficient system for

processing most tax returns. It had not significantly reduced the number of

paper returns it processes, nor had it delivered the new systems needed to

process paper documents more efficiently. IRS’ efforts to improve

customer service have also fallen short. Even if taxpayers were able to

reach IRS, agency assistors did not always have the information readily

available to answer their questions, and IRS has been slow in changing

work processes and implementing new information systems. Furthermore,

budget reductions and concerns over taxpayer burden led IRS to cancel or

postpone certain programs that were intended to help improve

compliance. Until IRS successfully modernizes its processes and

operations, we do not believe it will achieve its business vision.

Managing IRS: IRS Needs to Continue Improving Operations and Service

(GAO/T-GGD/AIMD-96-170, July 29, 1996). In our first statement before the

National Commission on Restructuring the Internal Revenue Service, we

shared some of the long-standing challenges that IRS faces as it strives to

improve its organization, operation, processes, and customer service.

These challenges include

• the inefficient manner in which IRS processes most tax returns;

• the managerial, technical, and human resource obstacles that hinder IRS

from fulfilling its customer service vision;

Page 2 GAO/GGD-97-122 1996 Annual Tax Report
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• the problems that continue to undermine the effectiveness of IRS’

collection programs;

• the need to resolve serious financial management problems that affect the

reliability of its financial statements; and

• the need to better coordinate its reengineering efforts, which could

generate new business requirements that are not addressed by TSM

projects or that make some of those projects obsolete.

Financial Audit: Examination of IRS’ Fiscal Year 1995 Financial Statements

(GAO/AIMD-96-101, July 11, 1996). In accordance with the Chief Financial

Officers Act of 1990, this report to Congress presented the results of our

efforts to audit IRS’ Principal Financial Statements for fiscal years 1995 and

1994. The report discussed IRS’ continuing financial management problems

in such areas as reconciling taxpayer revenue and refund accounts,

substantiating the amounts of various types of taxes it collects, verifying

nonpayroll operating expenses, and reliably reporting its accounts

receivable balances. It also described IRS’ weaknesses in its controls over

recordkeeping and computer security, and it contained our formal

opinions and reports on IRS’ financial statements, internal controls, and

compliance with laws and regulations.

Individual and

Business Tax Issues

IRS data indicate that the portion of the gap between taxes owed and paid

that can be attributed to individual taxpayers amounts to about $94 billion

per year. Of that amount, the failure to report income accounts for about

$73 billion. Tax law changes as well as changes to IRS’ taxpayer guidance

could increase compliance by making it easier for taxpayers to comply

with tax laws. Changes in IRS’ enforcement programs could make these

programs more effective and less intrusive on taxpayers.

Businesses play a significant role in our tax system. They not only pay

income taxes but are also responsible for providing information to taxing

authorities about payments to individuals and for withholding income and

Social Security taxes from employees’ salaries. IRS data indicate that the

portion of the tax gap attributable to corporate taxpayers amounts to

about $33 billion per year. Of this amount, large corporations account for

about $24 billion, and small corporations account for about $7 billion.

Businesses, particularly large corporations, also spend considerable sums

of money resolving disputes with IRS over audit results.

Internal Revenue Service: Results of Nonfiler Strategy and Opportunities

to Improve Future Efforts (GAO/GGD-96-72, May 13, 1996). Our report to the

Page 3 GAO/GGD-97-122 1996 Annual Tax Report
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Commissioner of Internal Revenue discussed our review of IRS’ strategy,

which began in fiscal 1993, to bring an estimated 10 million individual and

business nonfilers back into the system and keep them there. We assessed

the results of IRS’ strategy and determined whether opportunities existed

to improve any future nonfiler efforts.

According to IRS, the Nonfiler Strategy was generally a success. The

agency (1) reduced the size of the nonfiler inventory; (2) eliminated

unproductive cases, which allowed it to focus enforcement resources

more effectively; and (3) increased the number of returns secured from

individual nonfilers.

However, although IRS achieved its goal of reducing the backlog of nonfiler

investigations, it was unclear how much, if at all, voluntary taxpayer

compliance improved as a result of the strategy. The absence of

comprehensive cost data made it difficult to assess the return on IRS’

investment.

We identified several areas in which opportunities existed to improve any

future effort directed at nonfilers. These opportunities related to (1) the

time it took IRS to make telephone contact with nonfilers; (2) the use of

higher graded staff to perform tasks that might have been effectively

performed by lower graded staff; and (3) procedures for dealing with

recidivists—that is, nonfilers who were brought into compliance and then

became nonfilers again. We also recommended establishing measurable

goals and developing comprehensive data on program costs.

Tax Administration: IRS Is Improving Its Controls for Ensuring That

Taxpayers Are Treated Properly (GAO/GGD-96-176, Aug. 30, 1996). In this

report to the Chairman of the Senate Finance Committee, we addressed

continuing allegations of taxpayer abuse by IRS employees years after the

enactment of the Taxpayer Bill of Rights in 1988. We studied

• the adequacy of IRS’ controls to protect against taxpayer abuse;

• the extent of information available concerning abuse allegations received

and investigated by IRS, the Department of the Treasury’s Office of

Inspector General (OIG), and the Department of Justice; and

• the role of the Inspector General in investigating abuse allegations.

Owing to the lack of specific data elements on taxpayer abuse in the

information systems at IRS, Treasury’s OIG, and the Department of Justice,

we were unable to determine the adequacy of IRS’ system of controls that

Page 4 GAO/GGD-97-122 1996 Annual Tax Report
B-277179 

are used to identify, address, and prevent instances of abuse. However, we

were encouraged by IRS’ decision to develop a taxpayer complaint tracking

system that essentially adopts the definition of taxpayer abuse that is

included in our 1994 report.1

Customer Service IRS’ “Customer Service Vision” guides its efforts to improve customer

service. The vision is founded on increased accessibility, including

up-front problem identification, improved notices and publications,

telephone interaction in lieu of correspondence, one-stop service, and

blended work groups. As part of this effort, IRS is identifying new ways to

improve service and developing systems to support this service.

Tax Administration: IRS Faces Challenges in Reorganizing for Customer

Service (GAO/GGD-96-3, Oct. 10, 1995). As part of our continuing efforts to

provide Congress with the information and analyses it needs to improve

IRS’ tax administration, we reviewed the progress IRS was making toward

achieving its customer service vision. Our report discussed (1) IRS’ goals

for customer service and its plans to achieve them, (2) the gap between

current performance and these goals, (3) agency progress to date,

(4) current management concerns, and (5) several important challenges IRS

faces.

We found that although IRS had made some progress toward its customer

service vision, the agency’s lack of clarity in management responsibilities

had, to some extent, hampered its ability to implement its customer

service plans. IRS expects to improve its customer service by having fewer

work locations and automated workload management, giving customer

service representatives better access to taxpayer accounts, improving

taxpayer accessibility to telephone service, and allowing taxpayers to

resolve their inquiries after a single telephone contact. IRS has been

particularly slow, however, in improving taxpayer accessibility and

reassigning staff to customer service centers.

IRS needs to determine how to manage the transition to a different

organization while maintaining its ongoing workload, decide what the role

of customer service representatives will be, develop and effectively use

new information technology, and devise ways to measure the work of new

customer service centers and balance their competing workloads. We

recommended that IRS assign ownership and clearly define roles and

1

Tax Administration: IRS Can Strengthen Its Efforts to See That Taxpayers Are Treated Properly

(GAO/GGD-95-14, Oct. 14, 1994).

Page 5 GAO/GGD-97-122 1996 Annual Tax Report
B-277179 

responsibilities for its projects and emphasize the need to develop, test,

and implement new customer service products and services.

Tax Administration: Making IRS’ Telephone Systems Easier to Use Should

Help Taxpayers (GAO/GGD-96-74, Mar. 11, 1996). At the request of the House

Subcommittee on Oversight, Committee on Ways and Means, we reviewed

IRS’ development and use of interactive telephone systems to improve

customer service, focusing on IRS’ efforts to make the telephone systems

easier to use, protect taxpayer data, and assign responsibility for providing

developers with systems requirements information.

Three prototype interactive telephone systems—designed to reduce

correspondence between IRS and taxpayers and to make the agency more

accessible—suffered from too many menu options and other problems.

Future interactive systems may require more safeguards to protect

taxpayer data.

Resolving the shortcomings in the current systems is essential if IRS is to

achieve its goal of increasing interactive telephone assistance to

45 percent of taxpayers’ calls. We recommended that IRS conduct a

cost-benefit analysis of the actions needed to overcome the problems of

too many menu options, including the addition of multiple toll-free

numbers and publication of written instructions on how to use the

interactive menus.

Submission

Processing

IRS’ current procedures for processing tax returns are dependent on

antiquated technology, which will eventually be replaced through TSM.

Critical in that regard is the extent to which IRS can increase electronic

filings. Meanwhile, existing systems and capabilities must continue

functioning.

Tax Administration: Electronic Filing Falling Short of Expectations

(GAO/GGD-96-12, Oct. 31, 1996). In a report to the Senate Committee on

Governmental Affairs, we discussed IRS’ progress in broadening the use of

electronic filing, the availability of the data needed to develop an

electronic filing strategy, and the implications for IRS if it does not

significantly reduce its paper processing workload.

Although IRS has some data on the cost of processing electronic and paper

returns, it does not have comparative data on other costs, such as storage

and retrieval, that can vary depending on how a return is filed. IRS also

Page 6 GAO/GGD-97-122 1996 Annual Tax Report
B-277179 

does not have adequate data on why taxpayers do not file electronically

and what it would take to get them to do so, nor does it have estimates on

the number of electronic returns it could expect to receive after some

market intervention.

We recommended that IRS (1) identify those groups of taxpayers who offer

the greatest opportunity to reduce IRS’ paper processing workload and

operating costs if they filed electronically and (2) develop strategies that

seek to eliminate impediments that inhibit those groups from filing

electronically. We also recommended that IRS adopt electronic filing goals

that focus on reducing the paper processing workload and operating costs

and prepare contingency plans for the possibility that electronic filings

will fall short of expectations.

Accounts Receivable/

Collections

IRS’ accounts receivable is recognized by us and the Office of Management

and Budget (OMB) as a high-risk area. The primary reason for this

designation is that IRS’ efforts to collect the tens of billions of dollars

taxpayers owe in delinquent taxes have been inefficient and unbalanced.

Despite many initiatives to correct its accounts receivable problems, IRS

has made little sustained progress in resolving the problems at the root of

its collection performance.

Tax Administration: IRS Tax Debt Collection Practices (GAO/T-GGD-96-112,

Apr. 25, 1996). During its review of IRS’ debt collection practices, the House

Ways and Means Subcommittee on Oversight asked us to discuss the

challenges facing IRS and the potential benefits of involving private parties

in the collection of tax debts. IRS faces some formidable challenges in

collecting tens of billions of dollars in delinquent taxes, including

• a lack of accurate and reliable information on either the makeup of its

accounts receivable or the effectiveness of the collection tools and

programs it uses, and

• an aged inventory of receivables, outdated collection processes, and

antiquated technology.

This lack of reliable information on taxpayer accounts affects IRS’ ability to

determine whether its agents are resolving cases in the most efficient and

effective manner. Similarly, the lack of reliable performance data affects

IRS’ ability to target its collection efforts to specific taxpayers or specific

types of debts. We believe that IRS needs a long-term comprehensive

strategy to guide its efforts to improve tax debt collection, and such a

Page 7 GAO/GGD-97-122 1996 Annual Tax Report
B-277179 

strategy must start with accurate and reliable information. Without this

strategy, any changes made to the system may not provide the planned

results. We also believe that private industry may provide some help in

collecting tax debts by assisting in performing some collection-related

activities.

Tax Expenditures and

Preferences

Tax expenditures—tax provisions that grant special relief to encourage

certain behaviors or to aid taxpayers in special circumstances—cost

$400 billion of federal revenue annually. Tax expenditures are not subject

to systematic review, and policymakers have few opportunities to make

explicit comparisons between tax expenditures and federal spending

programs. Improving the effectiveness of tax expenditures can result in

significant savings.

Tax Policy and Administration: Review of Studies of the Effectiveness of

the Research Tax Credit (GAO/GGD-96-43, May 21, 1996). During a

congressional hearing in 1995, we were asked to evaluate recent studies of

the research tax credit to determine whether the evidence was adequate to

conclude that each dollar taken of the research tax credit stimulates at

least one dollar of research spending in the short run and about two

dollars of research spending in the long run.2

 In response to a

congressional request, we reviewed eight studies of the research tax

credit, focusing on

• the adequacy of the studies’ data and methods to determine the amount of

research spending stimulated per dollar of foregone tax revenue and

• other factors that determine the credit’s value to society.

The studies we reviewed indicated that the amount of research spending

stimulated by the research tax credit was larger than estimated by most of

the studies published during the 1980s. The eight studies, however,

provided mixed evidence on the amount of spending stimulated by the

credit per dollar of revenue cost.

Further, the estimates presented in recent studies do not provide all the

information needed to evaluate the effectiveness of the latest version of

the credit. The amount of research spending stimulated per dollar of

incentive revenue cost depends not only on the responsiveness of

spending to a tax incentive but also on the credit’s design. There has been

2

The May 10, 1995, hearing was held by the Subcommittee on Oversight, House Ways and Means

Committee.

Page 8 GAO/GGD-97-122 1996 Annual Tax Report
B-277179 

little research on how the latest design of the credit has affected incentives

and costs.

Although most of the studies we reviewed used more sophisticated

statistical techniques and more years of data than prior studies of the

credit, all of them had data and methodological limitations. For example,

the studies did not use tax return data to determine the credit’s incentive

because the authors did not have access to such confidential data.

Therefore, the authors had to rely on publicly available data, which used

different definitions of taxable income and research spending. As a result

of the data limitations, we were unable to conclude that a dollar of

research tax credit would stimulate a dollar of additional research

spending and, in the long run, lead to about two dollars of research

spending.

We are sending copies of this report to other congressional committees,

the Director of OMB, the Secretary of the Treasury, and the Commissioner

of Internal Revenue. Copies will also be available to others upon request.

Major contributors to this report are listed in appendix III. If you or your

colleagues would like to discuss any of the matters in this report, please

call me on (202) 512-9110.

Lynda D. Willis

Director, Tax Policy and

 Administration Issues

Page 9 GAO/GGD-97-122 1996 Annual Tax Report
Contents

Letter 1

Appendix I 

Summaries of

Tax-Related Products

Issued in Fiscal Year

1996

12

Appendix II 

Chronological Listing

of GAO Products on

Tax Matters Issued in

Fiscal Year 1996

50

Appendix III 

Major Contributors to

This Report

53

Abbreviations

DOD Department of Defense

EIC Earned Income Credit

IRC Internal Revenue Code

IRS Internal Revenue Service

NTIS National Technical Information Service

OID Original issue discount

OIG Office of Inspector General

OMB Office of Management and Budget

SSN Social Security number

TCMP Taxpayer Compliance Measurement Program

TSM Tax Systems Modernization

VA Veterans Affairs

Page 10 GAO/GGD-97-122 1996 Annual Tax Report
Page 11 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

IRS Management and

Budget

IRS Financial Audits: Status of Efforts to Resolve Financial

Management Weaknesses (GAO/T-AIMD-96-170, Sept. 19, 1996); Financial

Audit: Actions Needed to Improve IRS Financial Management

(GAO/T-AIMD-96-96, June 6, 1996); and IRS Operations: Significant

Challenges in Financial Management and Systems Modernization

(GAO/T-AIMD-96-56, Mar. 6, 1996). In testimony before the Subcommittee on

Government Management, Information and Technology, House Committee

on Government Reform and Oversight and before the Senate Committee

on Governmental Affairs, we discussed the results of our fiscal year 1994

financial audit of IRS. We found that IRS could not adequately verify or

reconcile, in total and by type of tax, the amount of revenue it collected or

the refunds it made for fiscal years 1992 through 1995. We also found large

discrepancies between information in IRS’ masterfiles and the Treasury

data used for various types of taxes.

Several internal control weaknesses contributed to IRS’ financial

management problems. For example, IRS was unable to provide adequate

documentation for numerous transactions posted to taxpayer accounts

and in its nonmaster file because the information had been lost, physically

destroyed, or was no longer maintained. In addition, taxpayer refunds

were not always screened by IRS employees, as required by IRS policy, to

determine whether the refunds could be offset against any outstanding

debts. The reliability of IRS’ $113 billion tax debt inventory was also in

question because IRS could not verify the accounts receivable balance or

the amounts that were considered collectible.

IRS also had problems in substantiating nonpayroll expenses and

reconciling appropriations available for expenditure with Treasury’s

central accounting records. This occurred, primarily, because IRS was

unable to provide support for when and if certain goods and services were

received. Not having this support made IRS vulnerable to receiving

inappropriate interagency charges and seriously undermined any effort to

provide reliable, consistent cost or performance information.

In our March 6, 1996, testimony, we also noted that IRS’ attempts to

modernize its tax processing systems were at serious risk because of

management and technical weaknesses. For example, IRS did not have a

comprehensive business strategy to cost-effectively reduce paper

submissions, and it had not yet fully developed and put in place the

requisite management, software development, and technical

infrastructures necessary to successfully implement its modernization

program. In addition, IRS failed to

Page 12 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

• manage the selection and acquisition of information systems as

investments,

• develop adequate cost-benefit analyses for its modernization proposals,

• implement quality assurance metrics for its software development

projects,

• require adequate systems and acceptance testing, and

• define standard interfaces before implementing interconnecting systems.

Over the past 4 years, we made 59 recommendations to improve IRS’

financial management systems and reporting and numerous other

recommendations to improve IRS’ modernization efforts. IRS agreed with

most of our recommendations and was working to improve its financial

management and information technology capability and operations.

However, we noted that many difficult problems remained, and IRS needed

to intensify and sustain its efforts.

IRS Operations: Critical Need to Continue Improving Core Business

Practices (GAO/T-AIMD/GGD-96-188, Sept. 10, 1996) and Internal Revenue

Service: Business Operations Need Continued Improvement

(GAO/AIMD/GGD-96-152, Sept. 9, 1996). In testimony before the Senate

Committee on Governmental Affairs, following on our report to the

Chairman and Ranking Minority Member, we discussed the problems IRS

was experiencing in fulfilling its business vision, overcoming management

and technical weaknesses in its TSM effort, and improving the reliability of

its financial management systems.

We said that IRS needed to develop an effective implementation strategy

for achieving its business vision. We suggested that such a strategy should

include developing the capacity to make sound investments in information

technology, building the necessary in-house technical expertise needed to

effectively manage its Tax Systems Modernization (TSM) projects, and

addressing the serious financial management problems that affect the

credibility of its financial information.

We also said that

• IRS, the Department of the Treasury, and the Office of Management and

Budget needed to ensure that IRS’ information management initiatives are

promptly and fully implemented;

• Congress should consider limiting IRS funding for TSM to critical and

cost-effective projects; and

Page 13 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

• the National Commission on Restructuring the Internal Revenue Service

would have a leading role in evaluating IRS’ operations and recommending

organizational, management, and operating changes.

Tax Systems Modernization: Actions Underway But Management

and Technical Weaknesses Not Yet Corrected (GAO/T-AIMD-96-165, Sept.

10, 1996) and Tax Systems Modernization: Cyberfile Project Was

Poorly Planned and Managed (GAO/AIMD-96-140, Aug. 26, 1996). In

testimony before the Senate Committee on Governmental Affairs, we

discussed IRS’ efforts to modernize its tax processing system. The

testimony followed up on our August report on Cyberfile.

Overall, we found pervasive management and technical problems with IRS’

modernization efforts. IRS had not defined a process for selecting,

controlling, and evaluating its technology investments; had not completed

procedures for requirements management, quality assurance,

configuration management, and project planning and tracking; and had not

defined its systems, security, and data architectures. A Treasury report

acknowledged that IRS did not have the capability to develop and integrate

its TSM effort, and although it directed that IRS obtain additional contractual

help to do so, it also acknowledged that IRS did not have the capability to

successfully manage all of its current contractors.

For example, IRS’ Cyberfile project was intended to enable taxpayers to

prepare and electronically submit their tax returns via personal

computers. However, IRS’ selection of the Commerce Department’s

National Technical Information Service (NTIS) to develop Cyberfile was not

based on sound analysis of NTIS’ ability to develop and operate an

electronic filing system, and in fact, development and acquisition were

undisciplined, and Cyberfile was poorly managed and overseen. In the end,

Cyberfile was not delivered on time, and IRS, after advancing more than

$17 million to NTIS, suspended Cyberfile’s development. During the project,

IRS and NTIS failed to follow all applicable procurement laws in developing

Cyberfile; NTIS circumvented procurement laws in implementing Cyberfile;

Cyberfile’s obligations and costs were not accounted for properly; and

adequate financial program management controls were not implemented

to ensure that Cyberfile would be cost-effective.

In the past, we made numerous recommendations to IRS relating to its

systems modernization effort. Although IRS had initiated activities intended

to begin responding to our recommendations, none of them had been fully

implemented.

Page 14 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

At the time of our testimony, IRS did not have

• the effective strategic information management practices needed to

manage its modernization efforts,

• the mature and disciplined software development processes needed to

ensure that systems built would perform as intended,

• a completed systems architecture that was detailed enough to guide and

control systems development and acquisition, and

• a schedule for accomplishing any of the aforementioned tasks.

Further, IRS did not manage all of its current contractual efforts effectively,

and its plans to use a “prime” contractor and transition much of its

systems development to additional contractors was not well defined.

In our testimony, we suggested that Congress consider limiting TSM

spending to only cost-effective modernization efforts that

• support ongoing operations and maintenance;

• correct IRS’ pervasive management and technical weaknesses;

• are small, represent a low technical risk, and can be delivered in a

relatively short time; and

• involve deploying already developed systems that have been fully tested,

are not premature given the lack of completed systems architecture, and

have proven business value.

Our testimony also suggested that Congress consider requiring that IRS

institute disciplined systems acquisitions processes and develop plans and

schedules before permitting IRS to increase its reliance on contractors.

In our August report, we recommended that IRS

• review the breakdown in its acquisition and financial management

processes and controls that permitted the mismanagement of Cyberfile

and

• take steps to correct the weaknesses and ensure that they are not repeated

on future projects.

We also recommended that the Department of Commerce

• review NTIS’ acquisition and financial management processes and controls

that permitted it to disregard procurement laws and regulations,

Page 15 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

• take steps to correct the weaknesses and ensure that they do not recur,

and

• not permit NTIS to accept new systems development projects from other

federal agencies until the weaknesses are corrected.

Managing IRS: IRS Needs to Continue Improving Operations and

Service (GAO/T-GGD/AIMD-96-170, July 29, 1996). In testimony before the

National Commission on Restructuring the Internal Revenue Service, we

discussed various challenges facing IRS as it tries to make its organization,

operations, and processes more effective and efficient and improve service

to taxpayers. Our testimony made the following points:

• One of IRS’ biggest problems has been the inefficient way in which it

processes most tax returns. IRS needs to develop an effective strategy to

reduce the volume of paper returns. Although IRS has taken some actions

to increase the number of electronic returns filed, it does not have a

comprehensive strategy to reach its electronic filing goal by 2001.

• IRS’ strategy for improving customer service offers promise because it is

designed to improve taxpayers’ ability to get assistance from IRS and

provide its employees with access to the information they need to help

taxpayers. However, IRS needs to develop a framework to overcome the

important managerial, technical, and human resource challenges it faces in

implementing this vision.

• Long-standing problems continue to undermine the effectiveness of IRS’

collection programs. To address these problems, significant changes are

needed in the way IRS does business.

• IRS has made some progress in resolving issues that prevented us from

expressing an opinion on the reliability of its financial statements;

however, serious financial management problems remain uncorrected.

• IRS needs to develop the capacity to make sound investment decisions in

information technology. The outcome of IRS’ reengineering efforts could

generate new business requirements that are not addressed by

modernization projects or that make some of those projects obsolete.

Financial Audit: Examination of IRS’ Fiscal Year 1995 Financial

Statements (GAO/AIMD-96-101, July 11, 1996). In accordance with the Chief

Financial Officers Act of 1990, we reported on our audit of IRS’ principal

financial statements for fiscal year 1995. We stated that

• we were unable to give an opinion on those statements or report on

compliance with laws and regulations because of limitations on the scope

of our work and

Page 16 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

• material weaknesses in internal controls resulted in ineffective controls

for safeguarding assets from material loss and for ensuring material

compliance with relevant laws and regulations.

The following five management problems undermined our ability to attest

to the reliability of IRS’ financial statements:

• The amount of total revenue ($1.4 trillion) and tax refunds ($122 billion)

could not be verified or reconciled to accounting records maintained for

individual taxpayers in the aggregate.

• The amount reported for various types of taxes, such as Social Security

and excise taxes, could not be substantiated.

• The reliability of estimates of $113 billion for valid accounts receivable

and $46 billion for collectible accounts receivable could not be

determined.

• A significant portion of IRS’ reported $3 billion in nonpayroll operating

expenses could not be verified.

• The amount IRS reported as appropriations available for expenditure for

operations could not be reconciled fully with Treasury’s central

accounting records.

IRS advised us of various steps it was taking to correct the problems our

audit identified (such as development of software programs to capture

detailed revenue and refund transactions), but we could not verify the

results of IRS’ efforts because they were not complete.

Tax Systems Modernization: Actions Underway But IRS Has Not Yet

Corrected Management and Technical Weaknesses (GAO/AIMD-96-106,

June 7, 1996). Pursuant to a legislative requirement, we reviewed IRS’

actions to correct the management and technical weaknesses we

identified in July 1995 that jeopardized IRS’ TSM efforts.1

 We found that

although IRS had initiated several corrective actions, many of them were

still incomplete; and none, either individually or in the aggregate, fully

responded to any of our recommendations.

For example, IRS had created an investment review board to select,

control, and evaluate its information technology investments. However,

the criteria for the board’s decisions were still undocumented and

undefined, and IRS still had not reviewed the basis for its planned and

ongoing systems. Furthermore, while IRS had completed a descriptive

1

Tax Systems Modernization: Management and Technical Weaknesses Must Be Corrected If

Modernization Is to Succeed (GAO/AIMD-95-156, July 26, 1995).

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overview of an integrated, three-tier, distributed systems architecture, it

had not completed the systems architecture nor its security and data

architectures, and there was no schedule for doing so.

IRS had not established an effective organizational structure to consistently

manage and control TSM. IRS had planned to use software development

contractors to develop TSM, yet its plans and schedules in this area were

poorly defined and could not be fully understood or assessed. Moreover,

as the experiences with Cyberfile and the Document Processing System

projects made clear, IRS did not have the mature processes needed to

acquire software and manage contractors effectively.

We suggested that Congress consider limiting TSM spending to only

cost-effective modernization efforts that

• support ongoing operations and maintenance;

• correct pervasive management and technical weaknesses;

• are small, represent low risk, and can be delivered quickly; and

• involve deploying already developed and fully tested systems that have

proven business value and are not premature given the lack of a

completed architecture.

Tax Systems Modernization: Progress in Achieving IRS’ Business

Vision (GAO/T-GGD-96-123, May 9, 1996). In testimony before the Senate

Committee on Governmental Affairs, we discussed IRS’ progress in

achieving its business vision for 2001 and modernizing its operations. IRS

has developed a vision for 2001 that calls for organizational, technological,

and operational changes affecting the way in which the agency processes

tax returns, provides customer service, and ensures compliance with tax

laws. IRS has made progress in modernizing its operations, but the

differences between IRS’ existing operations and those proposed in its

vision are great.

One of the biggest problems facing IRS is its inefficient system for

processing most tax returns. IRS has made little progress either in reducing

the number of paper returns it processes or in delivering the new systems

needed to improve paper processing. For example, IRS established a goal

to receive 80 million tax returns electronically by 2001, but it lacks a

comprehensive business strategy for achieving that goal.

The second part of IRS’ vision is to improve service to taxpayers.

Taxpayers have long had a problem reaching IRS by telephone, and when

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they do, IRS assistors do not always have easy access to the information

needed to resolve the problems. IRS’ strategy for improving customer

service includes consolidating work units, changing work processes, and

increasing the use of or implementing new information systems. It is a

promising strategy, but IRS faces many challenges in its implementation.

The third part of IRS’ vision is to increase compliance with tax laws.

Compliance levels have remained at 87 percent for the last several years,

and the goal is to increase compliance to 90 percent. IRS established that

goal on a set of assumptions that have since changed

significantly—changes that could jeopardize the achievement of its goal.

For example, budget and taxpayer burden concerns led IRS to postpone

indefinitely the Taxpayer Compliance Measurement Program (TCMP), the

results of which were to provide more up-to-date information for a new

compliance research information system.

We questioned IRS’ ability to make sound investment decisions until it

reengineers important processes, such as tax return processing. Until

clearly defined business requirements drive its modernization projects,

there is no guarantee that these projects will successfully improve IRS

operations.

Tax Administration: IRS’ Fiscal Year 1996 and 1997 Budget Issues

and the 1996 Filing Season (GAO/T-GGD-96-99, Mar. 28, 1996). In testimony

before the Subcommittee on Oversight, House Committee on Ways and

Means, we discussed budget issues facing IRS in fiscal years 1996 and 1997

and provided interim results on our review of the 1996 filing season.2

IRS’ 1996 appropriation totaled $7.3 billion—$860 million less than what the

President had requested and $160 million less than IRS’ fiscal year 1995

appropriation. To cover the resulting labor cost shortfall, IRS officials said

that they reduced travel and overtime costs, cash awards, hours for

seasonal staff, and the number of nonpermanent staff. IRS wanted to

ensure that it had enough staff to process returns and issue refunds, so

most of the cuts were absorbed by compliance programs.

IRS requested nearly $8 billion for fiscal year 1997, an increase of

$647 million from fiscal year 1996. The largest increases were for

compliance initiatives and TSM, two areas that have been plagued by

problems in the past. Concerning TSM, we expressed the belief that IRS

2

See our final report on the filing season, IRS’ 1996 Tax Filing Season: Performance Goals Generally

Met; Efforts to Modernize Had Mixed Results (GAO/GGD-97-25, Dec. 18, 1996).

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could not make effective use of systems development funds at that time

because it had not yet corrected managerial and technical weaknesses that

we had identified in July 1995.3

The interim results of our review of the 1996 filing season indicated that

• IRS was delaying fewer refunds than it did in 1995 while it validated Social

Security numbers (SSN) and Earned Income Credit (EIC) claims;

• taxpayers appeared to be having an easier time reaching IRS by telephone,

although accessibility was still low; and

• more taxpayers were using alternative filing methods.

Tax Systems Modernization: Management and Technical

Weaknesses Must Be Overcome to Achieve Success (GAO/T-AIMD-96-75,

Mar. 26, 1996). In testimony before the Senate Committee on

Governmental Affairs, we discussed the status of IRS’ TSM program. IRS had

spent more than $2.5 billion on TSM through fiscal year 1995 and planned to

spend a total of up to $8 billion through 2001. TSM is central to IRS’ vision of

a paper-free work environment in which taxpayer account updates are

rapid and taxpayer information is readily available to IRS employees

responding to taxpayer inquiries.

We found that IRS still

• did not have a comprehensive strategy to maximize electronic filings;

• assumed that it would receive specified funding for systems development

and technology, yet was unable to assure Congress that it could spend its

1996 and future TSM appropriations judiciously and effectively;

• did not have a complete and integrated systems architecture;

• did not have a single entity that had the responsibility and authority to

control all of its information systems projects;

• did not have key planning documents, risk analyses and alternate

solutions, or a formal process to define, manage, and control its Cyberfile

project;

• failed to provide adequate physical security and software controls for

Cyberfile;4

 and

• could not adequately document many of its financial transactions,

including revenue collections, or reconcile its accounts with those at the

Department of the Treasury.

3

Tax Systems Modernization: Management and Technical Weaknesses Must Be Corrected If

Modernization Is to Succeed (GAO/AIMD-95-156, July 26, 1995).

4

See Security Weaknesses at IRS’ Cyberfile Data Center (GAO/AIMD-96-85R, May 9, 1996).

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Status of Tax Systems Modernization, Tax Delinquencies, and the

Potential for Return-Free Filing (GAO/T-GGD/AIMD-96-88, Mar. 14, 1996). In

testimony before the Subcommittee on Treasury, Postal Service, and

General Government, House Committee on Appropriations, we discussed

IRS’ efforts to manage and implement its multibillion dollar TSM program

and to collect tens of billions of dollars in tax debts. We also discussed the

potential for implementing a return-free filing system.

Regarding TSM, we discussed weaknesses in IRS’ electronic filing strategy;

strategic information management; software development; systems

architecture, integration, and testing; and accountability and control of

systems modernization. These weaknesses must be corrected if TSM is to

succeed.

In the tax collection area, we noted that IRS’ efforts are hampered by

inaccurate and unreliable information, antiquated computer systems and a

rigid collection process, unintended problems with implementing

safeguards against taxpayer abuses, a lack of accountability in its

organizational structure, and staffing imbalances. As a result, IRS cannot

accurately identify how much money the government is owed or how

much of the debt is collectible.

We also discussed how return-free filing could reduce the filing burden of

many taxpayers while reducing the amount of paper IRS must process. We

discussed two forms of return-free filing: “final withholding” and “agency

reconciliation,” both of which would require several changes to the

current tax system.

In the final withholding system, the withholder of income taxes

determines the taxpayer’s liability and withholds that amount. While

taxpayers would save millions of hours in preparation time and millions of

dollars in preparation costs, employers would incur additional

administrative costs associated with their increased responsibilities. In the

agency reconciliation system, the tax agency determines the taxpayer’s tax

liability based on information documents. Under this system, taxpayers

would also save millions of hours in preparation time and millions of

dollars in preparations costs. With either system, IRS would save millions

of dollars in processing costs.

IRS Staffing Trends (GAO/GGD-96-73R, Jan. 31, 1996). In a letter to the

Chairman, Senate Committee on Finance, we provided information on IRS’

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staffing trends from fiscal years 1981 through 1996. This information

updated what we had reported in 1993.5

 We showed staffing data from two

sources—IRS’ annual reports and budgets. The annual report data showed

higher staffing levels because that source included staffing that was

funded through reimbursements from other agencies.

Individual and

Business Tax Issues

Tax Administration: Income Tax Treatment of Married and Single

Individuals (GAO/GGD-96-175, Sept. 3, 1996). This report, prepared at the

request of Senator Orrin G. Hatch, provides information on income tax

provisions in the Internal Revenue Code (IRC) that potentially create

“marriage penalties” or “marriage bonuses,” with respect to the tax liability

of married couples. A marriage penalty results when two married persons

have a greater tax liability than two single persons with the same total

income. Conversely, a marriage bonus results when a married couple owes

less taxes than two similarly situated single persons.

We identified 59 IRC provisions in which tax liability depends at least

partially on the taxpayer’s marital status. They include three sections most

commonly discussed in connection with marriage penalties and bonuses:

those on the tax rate, the standard deduction, and the EIC.

The 59 provisions can be grouped into 4 categories.

• One group of nine provisions, such as those on the tax rate and Social

Security taxation, makes some adjustment for the differences between

joint and single income, but adjustments for married couples filing jointly

are less than twice those allowed for single taxpayers.

• A second group of 15 provisions, such as those limiting capital losses and

the home-mortgage interest deduction, includes only one limitation that

applies equally to married and single taxpayers.

• A third group of nine provisions, such as those allowing a personal

exemption, treats married couples as if they are single individuals or

provides couples with twice the benefit allowed a single person.

• A fourth group of 26 provisions treats a married couple as a unit for tax

purposes.

The single most important factor that determines a provision’s effect on

married couples is how income is divided between spouses. Fifty-six of

the 59 tax provisions could result in a marriage penalty or bonus

depending on the taxpayer’s individual circumstances. Couples with

5

Tax Administration: Trends for Certain IRS Programs (GAO/GGD-93-102FS, May 26, 1993).

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disparate incomes generally could enjoy a marriage bonus, while couples

with equivalent incomes generally incur a marriage penalty. Other factors

affecting a couple’s tax liability include which spouse owns property, has

capital gains or losses, and is qualified for tax deductions and credits.

Insufficient data prevented us from quantifying the number of taxpayers

potentially subject to the various marriage penalties and bonuses

described in the report.

Tax Administration: IRS Is Improving Its Controls for Ensuring

That Taxpayers Are Treated Properly (GAO/GGD-96-176, Aug. 30, 1996).

Allegations of taxpayer abuse prompted Congress to pass the Taxpayer

Bill of Rights in 1988. Six years later, we issued a report urging IRS to

strengthen its controls for ensuring that taxpayers are treated properly.6

Pursuant to a request from the Chairman, Senate Committee on Finance,

we examined the adequacy of IRS’ controls to protect against abuse of

taxpayers; the extent of information available concerning abuse

allegations received and investigated by IRS, Treasury’s Office of the

Inspector General (OIG), and the Department of Justice; and the OIG’s role

in investigating abuse allegations.

IRS had initiated actions to implement many of the recommendations we

made in our 1994 report and had initiated other actions in anticipation of

provisions included in Taxpayer Bill of Rights 2 (P.L. 104-168). Among

other things, IRS was improving controls over employee access to

computerized taxpayer accounts; establishing an expedited appeals

process for some collection actions; and classifying recurring taxpayer

problems by major issues, such as penalties imposed on taxpayers. Those

actions, if effectively implemented, could improve IRS’ overall treatment of

taxpayers and better protect against taxpayer abuse.

Despite IRS’ actions, we were unable to reach a conclusion on the overall

adequacy of its controls because it did not yet have the capability to

capture needed management information. IRS was establishing a tracking

system for taxpayer complaints and reviewing its management information

systems to determine the best way to capture relevant information for that

system. If effectively designed, such a system could better allow IRS to

ensure that instances of taxpayer abuse are identified and addressed and

that actions are taken to prevent their recurrence.

6

Tax Administration: IRS Can Strengthen Its Efforts to See That Taxpayers Are Treated Properly

(GAO/GGD-95-14, Oct. 26, 1994).

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We were not able to determine the extent to which allegations of taxpayer

abuse were received and investigated because the information systems at

IRS, Treasury OIG, and Justice did not include specific data elements on

taxpayer abuse. Treasury OIG officials said that they generally handled

allegations involving IRS executives but often referred allegations involving

lower level managers to IRS for investigation and administrative action.

Although we did not independently test the effectiveness of this

arrangement, we found no evidence to suggest that these allegations were

not being properly handled.

Tax Administration: Tax Compliance of Nonwage Earners

(GAO/GGD-96-165, Aug. 28, 1996). At the request of the Chairman,

Subcommittee on Oversight, House Committee on Ways and Means, we

provided information regarding the tax implications of the rapid growth in

nonwage income. Nonwage income has grown significantly since 1970,

when it accounted for 16.7 percent of total income for individuals. For tax

year 1992, the most recent available information at the time we did our

work, nonwage income accounted for over 23 percent (or $859 billion) of

total income for individuals. Individual tax returns showing only nonwage

income increased from about 10 percent in 1970 to over 15 percent in

1992. The six largest sources of nonwage income—pensions, interest,

self-employment, capital gains, dividends, and partnerships/subchapter S

corporations—accounted for 91.6 percent of all nonwage income reported

for 1992. Pension income was by far the largest and fastest growing source

of nonwage income.

IRS data showed that taxpayers who earned most of their income from

nonwage sources were more likely to have problems paying their taxes

than were wage earners and, as a result, owed more delinquent taxes than

did wage earners. Approximately 74 percent of IRS’ inventory of tax debt

for individual taxpayers at the end of fiscal year 1993 was owed by

taxpayers with primarily nonwage income. Taxpayers with

self-employment, interest, and dividend income accounted for about

two-thirds of this nonwage income.

The proportion of the taxpayer population reporting nonwage income will

continue to increase as the population ages because pension income is the

largest and fastest growing source of nonwage income. Options for

improving timely tax payments on nonwage income include withholding

income taxes on more sources of nonwage income, increasing taxpayer

awareness of tax payment responsibilities for nonwage income, and

modifying the estimated tax payment system.

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Tax Administration: Issues in Classifying Workers as Employees or

Independent Contractors. (GAO/T-GGD-96-130, June 20, 1996). In testimony

before the Subcommittee on Oversight, House Committee on Ways and

Means, we discussed the classification of workers for federal tax

purposes. To determine the Social Security and unemployment taxes they

need to pay on employee wages, employers must classify workers as

employees or independent contractors. If workers are determined to be

employees, employers must (1) withhold and deposit income and Social

Security taxes from wages paid and (2) pay unemployment taxes and the

employers’ share of Social Security taxes. Independent contractors pay

their own Social Security and income taxes.

For 1984, the last time IRS made a comprehensive estimate, IRS estimated

that about 750,000 of the more than 5 million employers (15 percent)

misclassified 3.4 million employees as independent contractors. This

noncompliance resulted in an estimated loss of $1.6 billion in Social

Security, unemployment, and income taxes. IRS studies indicate that

independent contractors, compared with employees, have a much lower

level of income tax compliance and account for a higher proportion of the

income tax gap. IRS completed 12,983 employment tax examination

program audits from 1988 to 1995. Those audits recommended

$830 million in employment tax assessments and reclassified 527,000

workers as employees.

Costs and unclear classification rules can contribute to this

noncompliance. Employers can lower their costs, such as payments of

employment taxes or benefits, by using independent contractors. Also,

many employers struggle in making the classification decision because of

unclear rules. Employers cannot be certain that their classification

decisions will withstand challenges by IRS. If not upheld, they risk large

retroactive tax assessments.

Two approaches that could boost independent contractor compliance

within existing classification rules include (1) improving information

reporting on payments made to independent contractors and

(2) withholding income taxes from such payments. These approaches

could also increase, to some extent, the burdens on independent

contractors and employers that use them.

Tax Research: IRS Has Made Progress But Major Challenges Remain

(GAO/GGD-96-109, June 5, 1996). IRS is changing its tax compliance philosophy.

Although it will continue to use enforcement to catch noncompliance, IRS

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is trying to induce compliance through nonenforcement work, such as

taxpayer assistance and education. This new approach involves

researching ways to improve compliance for specific market

segments—groups of taxpayers who share characteristics or behaviors. IRS

wants to boost total compliance to 90 percent by 2001 and believes that its

new compliance research approach will help meet this goal. Taxpayer

compliance in paying taxes owed has remained steady during the past 20

years at about 87 percent, and IRS estimates annual tax losses from

noncompliance at more than $100 billion.

In a report to the Commissioner of Internal Revenue, we discussed IRS’

new compliance research approach. Our analysis indicated that the

success of this new approach would depend on the support it received

throughout IRS, the availability of objective compliance data and skilled

research staff, the infrastructure for organizing and managing the

research, and the measures used to evaluate how well the new approach

works.

We found only mixed support for the new research approach. Many IRS

officials questioned whether it would help achieve the 90-percent

compliance goal, and there was disagreement over the initiative’s national

focus, with many officials preferring a district-level one. In addition, IRS

did not have a reliable source of objective compliance data, did not have

research staff with the specialized skills needed to achieve the initiative’s

research objectives, and had not completed its development of a

management infrastructure or a process for measuring the results of the

new approach.

We recommended that IRS develop an approach for monitoring the

effectiveness of mechanisms established to build support for the new

approach as well as for the staff-sharing and training efforts that were

under way, devise a method to better ensure that reliable compliance data

are available when needed, and establish milestones for completing the

management infrastructure and performance measures.

Internal Revenue Service: Results of Nonfiler Strategy and

Opportunities to Improve Future Efforts (GAO/GGD-96-72, May 13, 1996).

At the beginning of fiscal year 1993, IRS had an inventory of about

10 million individual and business nonfilers. IRS estimated that unpaid

taxes on nonfiled individual income tax returns for 1992 alone totaled

more than $10 billion. Concerned about this noncompliance, IRS began a

strategy in fiscal year 1993 to bring nonfilers into the system and keep

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them there. We reviewed IRS’ Nonfiler Strategy to assess the results and to

determine whether there were opportunities to improve future nonfiler

efforts.

IRS took several positive steps to achieve the goals of the Nonfiler Strategy.

Among other things, the Examination function deployed staff to work on

nonfiler cases; other IRS functions increased their emphasis on nonfiler

activities; and IRS eliminated old cases from inventory, established

cooperative working arrangements with states and the private sector, and

implemented a refund hold program.

According to IRS, the Nonfiler Strategy was generally a success. Among

other things, IRS reduced the size of the nonfiler inventory; eliminated

unproductive cases, which allowed it to focus enforcement resources

more effectively; and increased the number of returns secured from

individual nonfilers.

However, the results of the Strategy were less conclusive when compared

with its goals. IRS achieved its goal of reducing the backlog of nonfiler

investigations. However, there was insufficient information with which to

judge whether voluntary taxpayer compliance improved as a result of the

Strategy, and the absence of comprehensive cost data made it difficult to

assess return on investment.

We identified several areas in which opportunities existed to improve any

future IRS effort directed at nonfilers. Those opportunities related to

• the time that elapsed before IRS made telephone contact with nonfilers,

• the use of higher graded staff to perform tasks that might be effectively

done by lower graded staff, and

• procedures for dealing with nonfilers who are brought into compliance

and then become nonfilers again.

Besides making recommendations on those areas, we recommended that

IRS establish measurable goals and develop comprehensive data on

program costs to better assess the results of future nonfiler efforts.

Tax Administration: Audit Trends and Results for Individual

Taxpayers (GAO/GGD-96-91, Apr. 26, 1996). In response to a request from the

Chairman, Subcommittee on Oversight, House Committee on Ways and

Means, we provided information on

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• the trend in IRS’ audit rates for individual returns (i.e., the percentage of

individual income tax returns filed that are audited) and

• the overall results of IRS’ most recent audits of individual returns.

The audit rate for individuals decreased between fiscal years 1988 and

1993 from 1.57 percent to 0.92 percent, which, according to IRS officials,

resulted from an increase in the total number of returns filed, the

additional time spent auditing complex returns, and an overall reduction in

examination staffing. The audit rate rebounded over the next 2 years,

increasing to 1.67 percent by fiscal year 1995. IRS officials attributed the

increase to the involvement of district office auditors in pursuing nonfilers

and an emphasis on reviewing EIC claims—work that historically was not

counted as audits.

Audit rates varied widely by geographic location, with the rates being the

highest in the western regions of the country and lowest in the middle

regions. In general, audits of the highest income individuals resulted in

more additional recommended tax per return than did audits of the lowest

income individuals by as much as 4 to 5 times more. However, the amount

of additional recommended tax per audit hour for the highest income

individuals was less than twice that for the lowest income filers because of

the time needed to audit the more complex returns of the former.

Tax Administration: Alternative Strategies to Obtain Compliance

Data (GAO/GGD-96-89, Apr. 26, 1996). In October 1995, IRS decided to

postpone indefinitely the 1994 Taxpayer Compliance Measurement

Program because of budget concerns. In addition, Congress, taxpayer

groups, paid preparers, and others exerted considerable pressure to cancel

the program because of its cost to and burden on taxpayers. For more

than 30 years, this program has been IRS’ primary means for gathering

comprehensive and reliable taxpayer compliance data. IRS has used the

data to

• identify areas in which tax law needs to be changed to improve voluntary

compliance,

• estimate the tax gap and its components, and

• objectively select returns to audit that have the most potential for

noncompliance.

In this report to the Commissioner of Internal Revenue, we assessed the

potential effects on IRS’ compliance programs of postponing the 1994 TCMP

and identified some potential short- and long-term TCMP alternatives.

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IRS officials told us that they did not know how IRS would obtain the

taxpayer compliance data it needs, and they recognized that the loss of

1994 TCMP data could increase compliant taxpayers’ burden over the long

term because audits may become less targeted. To mitigate data losses

over the short term, IRS could employ several alternatives, including doing

a smaller survey. A limited survey would reduce the quantity and quality of

the data collected, but still provide statistically valid national compliance

data.

Without TCMP, IRS must determine how it will measure compliance over the

long term, since its workload and future revenues depend on taxpayers’

voluntary compliance. Long-term alternatives include

• conducting small multiyear TCMP-type audits from smaller samples and

combining the data from several years to ensure the necessary precision

and coverage,

• using data from operational audits to assess compliance changes, and

• conducting periodic national mini-TCMP audits to identify emerging issues.

Each of these alternatives would be cheaper and less burdensome to IRS

and taxpayers than the proposed TCMP sample but would also provide less

comprehensive compliance data.

We noted that regardless of how IRS decides to replace the information

that would have been provided by TCMP, it was important for IRS to begin

soon because any alternative is likely to require several years to put into

place, and the data will be needed to update information on IRS’

compliance programs.

We recommended that IRS identify a short-term strategy to minimize the

negative effects of the compliance information that was likely to be lost

because TCMP was postponed and develop a cost-effective, long-term

strategy to ensure the continued availability of reliable compliance data.

Tax System: Issues in Tax Compliance Burden (GAO/T-GGD-96-100,

Apr. 3, 1996). Businesses and individuals spend time and money—and

sometimes experience frustration—trying to comply with federal, state,

and local tax requirements. We refer to this experience as the “taxpayer

compliance burden.” In testimony before the Subcommittee on National

Economic Growth, Natural Resources, and Regulatory Affairs, House

Committee on Government Reform and Oversight, we discussed

information that we collected on the federal tax compliance burden from

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businesses, tax accountants, tax lawyers, representatives of tax

associations, and IRS staff.

According to those interviewed, the compliance burden is caused by the

tax code’s complexity, ambiguous language, and frequent changes. As a

result, many businesses are uncertain about what they must do to comply

with the code. Recordkeeping, time-consuming calculations, the interplay

of state and local tax requirements, and IRS’ administration of the tax code

add to the burden. Concerning the latter, the officials who were

interviewed identified several problems. Primarily, those problems

centered around the tax knowledge of IRS’ auditors, the clarity of IRS’

correspondence and notices, and the amount of time IRS takes to issue

regulations. Estimating businesses’ tax compliance burden and costs

would be difficult since businesses do not collect the data needed to make

reliable estimates.

The greatest reduction in the tax compliance burden could be gained by

simplifying the tax code. Return-free filing alternatives used in other

countries could reduce individual taxpayers’ tax compliance and IRS

administrative burdens; but employers, tax preparers, and state tax

systems could be further burdened or adversely affected. Reducing

businesses’ and individuals’ tax compliance burdens will be difficult

because of the tax policy trade-offs, such as revenue, equity, and social

and economic issues.

Tax Administration: IRS Can Improve Information Reporting for

Original Issue Discount Bonds (GAO/GGD-96-70, Mar. 15, 1996).

Information reporting is a vital tool for promoting voluntary compliance

with U.S. income tax laws. This reporting, which is done through a series

of returns designed to report nonwage income on IRS Form 1099, is

intended to ensure that taxpayers know of and report investment and

other income on their tax returns. In a report to the Commissioner of

Internal Revenue, we provided information on IRS’ efforts to ensure that

taxpayers report investment income earned from bonds sold at original

issue discount (OID), focusing on the completeness and use of IRS

Publication 1212, List of Original Issue Discount Instruments.

7

IRS asserted that brokerage firms, banks, and investment managers could

rely on Publication 1212 to identify all publicly offered OID bonds and

compute OID income; however, many OID bonds were missing from

Publication 1212. We identified at least 37 bonds worth billions of dollars

7

Generally, the term “OID” covers bonds sold at a discount—that is, below their redemption value.

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that should have been listed but were not. IRS’ source of information for

Publication 1212 is Form 8281, Information Return for Publicly Offered

Original Issue Discount Instruments, which is filed by bond issuers. IRS

primarily relied on its sizable penalty (up to $50,000) to ensure that OID

bond issuers file Form 8281. However, no IRS organization had primary

responsibility for monitoring such compliance, and there was no evidence

that IRS had ever assessed the penalty for failure to file or for late filings.

IRS did not use any other information it received, such as corporate tax

returns, to help ensure compliance with Form 8281 reporting

requirements. Because Publication 1212 was not complete, those who

relied on it to determine their information reporting requirements could

not be sure they were reporting all OID income to IRS or to bond owners.

We recommended that IRS assign responsibility for monitoring and

enforcing the OID bond issuance reporting requirements to specific

organizational units and that IRS develop procedures, such as computer

matching, to help ensure that all OID information is listed in Publication

1212. We also recommended that IRS work with representatives of the

securities industry to develop means to inform and remind OID bond

issuers of their responsibility to file Form 8281.

Tax Administration: Diesel Fuel Excise Tax Change (GAO/GGD-96-53,

Jan. 16, 1996). At the request of Senator Daniel Patrick Moynihan, we

reported on changes in diesel fuel excise tax collections in 1994, IRS’

responses to concerns about its regulations implementing new diesel fuel

taxation requirements, and incentives to evade motor fuel excise taxes or

obtain false refunds.

IRS data indicated that diesel fuel excise tax collections increased about

$1.2 billion, or 22.5 percent, from 1993 to 1994. Treasury estimated that

increased tax compliance accounted for between $600 million and

$700 million of the additional collections.

IRS addressed two major concerns about the dyeing requirements in its

regulations by settling on one dye color (red) rather than two and delaying

any action on using colorless markers to indicate tax-free fuel until the

effectiveness of the dyeing program could be determined. However, IRS

had not addressed several concerns, including

• the taxation of diesel fuel additives,

• the appropriate concentration level of red dye to avoid possible adverse

effects on engines,

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• the potential impact on the availability of diesel fuel for recreational

boating use,

• requests that the state of Alaska be exempted from the dyeing

requirements, and

• the effects of using dyed fuel in intercity buses on companies’ operating

cost and their ability to comply with EPA regulations.

The new diesel taxation approach appeared to be raising significant

additional revenue; however, anyone who wished to defraud the system

continued to have significant incentives to do so. For example, evading

just the federal tax on an 8,000-gallon truckload of diesel fuel would yield

an illicit profit of $1,920. IRS had detected several fraudulent schemes

involving refunds of gasoline or diesel fuel excise taxes, but it did not

know how extensive this fraud might be.

Tax Administration: Audit Trends and Taxes Assessed on Large

Corporations (GAO/GGD-96-6, Oct. 13, 1995). We reviewed the results of IRS’

efforts to audit the tax returns of about 45,000 large corporations. IRS’

audits of those returns and the returns of the 1,700 largest corporations in

IRS’ Coordinated Examination Program have generated about two-thirds of

the additional taxes recommended from all income audits. Using IRS data,

we analyzed audit trends for fiscal years 1988 through 1994, computed the

rate at which taxes recommended by agents were assessed, and developed

profiles of audited large corporations and compared them with large

corporations that were not audited.

For every dollar invested in large corporation audits, IRS recommended $56

and ultimately assessed $15 in additional taxes for the years 1988 through

1994. IRS invested more hours in directly auditing large corporations but

recommended less additional tax per hour invested in 1994 than in 1988. In

1994, IRS spent 25 percent more hours and audited only 3 percent more

returns. Further, in 1994 constant dollars, additional taxes recommended

decreased 4 percent in total, decreased 7 percent per return audited, and

decreased 23 percent per audit hour. In 1994, large corporations appealed

66 percent of the additional taxes that IRS recommended in its audits.

Between 1988 and 1994, IRS assessed 27 percent of the recommended

additional taxes either after agreement or resolution in appeals. This

assessment rate varied widely when disaggregated. For example, the rate

reached as high as 103 percent and fell to less than 1 percent at 20 IRS

districts that recommended over $100 million in additional taxes during

the 7 years we analyzed. The reasons for such disparate rates were not

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apparent. IRS believed that the assessment rate was not an accurate

measure of audit effectiveness since various factors outside the audit

(such as economic conditions or net operating losses) could lower the

rate.

Our profiles of large corporations showed that most were engaged in

either manufacturing or the finance and insurance industries in 1992.

Audited corporations tended to report higher average incomes, tax

liabilities, and other tax amounts than nonaudited corporations.

Tax Administration: Information on IRS’ Taxpayer Compliance

Measurement Program (GAO/GGD-96-21, Oct. 6, 1995). In response to a

request from Representative Joseph K. Knollenberg, we provided

information on IRS’ TCMP for tax year 1994.

IRS had generally taken appropriate action on the concerns raised in our

1994 report that dealt with meeting milestones for starting TCMP audits,

testing TCMP database components, developing data collection systems,

and collecting and analyzing data.8

 Because of uncertainties about its

fiscal year 1996 budget, IRS had delayed the start of its TCMP audits from

October 1 to December 1, 1995. This delay was fortuitous because IRS had

not completed testing the TCMP database components and data collection

systems.9

IRS had planned to collect data on partners, shareholders, and

misclassified workers as we suggested in our 1994 report. These additional

data should have allowed IRS to improve its measure of compliance levels.

IRS had also planned to have auditors computerize some of their comments

on audit findings, which should have made it easier for researchers to

analyze TCMP results. However, IRS had not developed a research plan that

could be used to analyze final TCMP results.

We also reported that

• we knew of no other IRS or third-party data that could be used to develop

return selection formulas that would allow IRS to target its audits as

effectively as TCMP data and

• TCMP could be very useful, not only for improving compliance in the

existing tax system but also as a tool for designing and administering a

new system.

8

Status of the Tax Year 1994 Compliance Measurement Program (GAO/GGD-95-39, Dec. 30, 1994).

9

IRS subsequently decided to postpone this TCMP indefinitely.

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Customer Service Tax Administration: Making IRS’ Telephone Systems Easier to Use

Should Help Taxpayers (GAO/GGD-96-74, Mar. 11, 1996). In a report to the

Chairman, Subcommittee on Oversight, House Committee on Ways and

Means, we discussed IRS’ efforts to develop interactive telephone systems,

focusing on IRS’ efforts to make the telephone systems easier to use, meet

security requirements for protecting taxpayer data, and assign “process

owners” who would be responsible for providing developers with input

about systems’ requirements.

Three prototype interactive telephone systems—designed to reduce

correspondence between IRS and taxpayers and to make IRS more

accessible—suffered from too many menu options and other problems. IRS’

telephone-routing system required taxpayers to remember up to eight

menu options—even though guidelines called for no more than four—and

did not allow taxpayers to return to the main menu when they made a

mistake or wanted to resolve other issues. IRS was aware of the menu

problems, but it believed that multiple options were necessary because tax

issues are complex. IRS had yet to do a cost-benefit analysis of the use of

multiple toll-free numbers, which IRS officials had recommended as a

solution to the problem of too many menu options. Providing taxpayers

with a written, detailed step-by-step description on how to use the menu

options might be another way to make the telephone systems more user

friendly.

IRS complied with government security requirements when developing its

first three interactive telephone systems. However, future interactive

systems should allow taxpayers greater access to tax information; and

more secure features, such as a personal identification number, may be

needed to protect taxpayer data. IRS process owners were designated late

and had not provided all the requirements information needed for the

telephone systems’ development.

Successful IRS implementation of interactive telephone systems is critical

to improving IRS customer service. IRS expects telephone assistance to

double as it tries to move toward a paperless system. Resolving the

shortcomings discussed in this report is essential if IRS is to achieve its

goal of handling 45 percent of taxpayer calls through interactive telephone

systems. We recommended that IRS conduct a cost-benefit analysis of the

actions needed to overcome the problems caused by too many menu

options, including multiple toll-free numbers and written instructions on

how to use the interactive menus.

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Tax Administration: IRS Faces Challenges in Reorganizing for

Customer Service (GAO/GGD-96-3, Oct. 10, 1995). IRS is undergoing a major

effort to modernize its information systems and restructure its

organization. This effort involves several components, one of which IRS

calls its “customer service vision.” This vision is a plan for improving IRS’

interactions with taxpayers and includes folding parts of IRS’ field structure

into 23 customer service centers. These centers would work primarily by

telephone to provide taxpayer service, distribute forms, collect unpaid

taxes, and adjust taxpayer accounts. They would absorb current IRS

telephone operations and help to convert much of IRS’ written

correspondence work to the telephone.

In a report to the Chairmen and Ranking Minority Members of interested

congressional committees, we reviewed the progress IRS had made toward

its customer service vision. We focused on

• IRS’ customer service goals and its plans to meet these goals,

• the gap between IRS’ current operations and its vision,

• IRS’ progress to date in meeting its goals,

• current management concerns, and

• important challenges IRS faces.

IRS’ customer service goals are to provide better service to taxpayers, use

its resources more efficiently, and improve taxpayers’ compliance with tax

laws. IRS plans to serve taxpayers better by improving their access to

telephone service and resolving most problems with a single contact. IRS

expects to improve its efficiency by having fewer work locations and

automated workload management, giving customer service

representatives better computer resources and nationwide access to

taxpayer accounts, and converting work currently done by

correspondence to the telephone. IRS expects to improve compliance by

answering more taxpayer inquiries and having more timely data to follow

up on compliance problems.

There was a large gap between IRS’ current operations and its customer

service vision. For example, although IRS planned to improve accessibility,

taxpayers who called IRS’ toll-free telephone assistance sites in fiscal year

1994 got busy signals 73 percent of the time. IRS had made some progress

toward its vision by initiating limited operations in a few new customer

service centers, but only a few staff had been reassigned to those centers,

and new computer and telephone systems to support the centers were still

in the early stages of development and testing.

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A lack of clarity in management responsibilities had, to some extent,

hampered IRS in implementing its customer service plans. In that regard,

we noted that no single individual was responsible for the success of all

the work activities and resources that were to be transferred to customer

service. We also discussed the absence of owner involvement during

project development and the failure of owners to establish the quality

measures critical to evaluating the performance of interactive telephone

systems.

IRS would have to overcome several important challenges to achieve its

customer service goals. Those challenges included

• managing the transition to a different organization while maintaining

ongoing workloads,

• developing and effectively using new information technology, and

• devising ways to measure the work of the customer service centers and

balance their competing workloads.

We recommended that IRS clarify the criteria for assigning ownership for

its modernization projects; define roles and responsibilities for those

owners; and emphasize to owners the need to provide the business

requirements necessary to develop, test, and implement new customer

service products and services.

Submission

Processing

Earned Income Credit: IRS’ 1995 Controls Stopped Some

Noncompliance, But Not Without Problems (GAO/GGD-96-172, Sept. 18,

1996). At the request of the Chairman, Senate Committee on Finance, we

reviewed IRS’ efforts to reduce EIC noncompliance. IRS took several steps to

prevent and detect EIC noncompliance in 1995. Those steps stopped some

noncompliance; however, a number of problems remained.

The up-front controls used by IRS in its Electronic Filing System

• identified about 1.3 million problems with SSNs on submissions from

persons who were claiming EIC and

• prevented the affected returns from being filed electronically until the

problems were corrected.

However, IRS’ increased emphasis on validating SSNs on paper returns

generated a workload that far exceeded its capabilities. IRS identified

about 3.3 million paper returns with missing or invalid SSNs for

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EIC-qualifying children or dependents and delayed related refunds, but it

only had the resources to follow up on 1 million cases. IRS also delayed

refunds on another 4 million EIC returns that did not have any SSN problems

to give itself time to check for duplicate SSNs, only to release almost all of

those refunds without checking.

Although IRS’ data provided some evidence of the results of its efforts in

1995, they were not sufficient to allow an overall assessment of the impact

of IRS’ initiatives on EIC noncompliance. For example,

• IRS had not yet released the results of an EIC compliance study that it did in

1995,

• data on the results of the SSN verification effort for paper returns were not

reported in a way that isolated tax year 1994 cases from prior years’ cases

or distinguished between EIC cases and cases involving dependents, and

• IRS did not track what happened to returns rejected by the Electronic

Filing System.

We recommended that IRS consider cost-effective ways to compile the data

needed to better assess the effectiveness of its efforts to combat EIC

noncompliance.

Tax Refund Timeliness (GAO/GGD-96-131R, June 26, 1996). At the request of

the Chairman, House Committee on Ways and Means, we reviewed the

processing and issuance of income tax refund payments in 1996 and

compared that year’s pattern with the patterns in 1994 and 1995. The

Chairman’s request was prompted by a concern that the timing of income

tax refund payments might be manipulated to avoid reaching the debt

limit.

Our work indicated that

• the number and dollar amount of refunds issued as of the end of April 1996

either exceeded or closely approximated the end-of-April figures for 1994

and 1995 and

• the average number of days for issuing refunds in 1996 was the same as in

past years.

Also, our tracking of returns processed by the Kansas City Service Center

showed nothing unusual. Thus, we concluded that there was no evidence

that any special steps were taken in 1996 to delay refunds. However, that

did not mean that no refunds were delayed in 1996. As in 1995, but to a

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much lesser degree, IRS delayed some refunds in 1996 to verify SSNs and EIC

claims.

IRS Efforts to Control Fraud in 1995 (GAO/GGD-96-96R, Mar. 25, 1996). At

the request of the Ranking Minority Member of the Senate Committee on

Governmental Affairs, we reviewed the status and results of IRS’ efforts to

reduce its exposure to fraud in 1995. IRS introduced new controls and

expanded existing controls to both deter the filing of fraudulent returns

and identify questionable returns once they had been filed. IRS’ efforts to

deter fraud appear to have had a positive effect, but the identification of

questionable returns was less successful.

To deter the filing of fraudulent returns, IRS established filters to screen

electronic submissions for missing, invalid, or duplicate SSNs and to

prevent those returns from being filed electronically until the problems

were corrected. The electronic filing filters identified 4.1 million SSN

problems in 1995. IRS also

• expanded its process for determining the suitability of tax return

preparers and transmitters who wanted to participate in the electronic

filing program and

• eliminated the Direct Deposit Indicator because of concern that it might

have encouraged filing fraud by facilitating refund anticipation loans.

To improve the identification of noncompliance on returns after they had

been filed, IRS

• placed an increased emphasis on validating SSNs on paper returns and

delayed refunds to give itself time to do those validations and to check for

possible fraud and

• upgraded the Questionable Refund Program.

As a result, IRS prevented the issuance of millions of dollars in

questionable refunds. However, IRS also

• identified many more SSN problems than it was able to deal with and ended

up releasing the refunds without resolving the problems and

• delayed millions of refunds with valid SSNs to check for duplication, but

ended up releasing those refunds after several weeks without checking the

SSNs.

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The 1995 Tax Filing Season: IRS Performance Indicators Provide

Incomplete Information About Some Problems (GAO/GGD-96-48, Dec. 29,

1995). In response to a request from the Chairman, Subcommittee on

Oversight, House Committee on Ways and Means, we reviewed IRS’

performance during the 1995 tax filing season. We focused on the

processing of individual income tax returns and refunds, the ability of

taxpayers to reach IRS by telephone, and the performance of a new IRS

computer system for processing returns.

IRS’ indicators showed that it generally met its 1995 filing season goals. For

example, IRS received more individual income tax returns than the year

before; answered 11 percent more telephone calls than expected; issued

refunds faster, on average, than its 40-day goal; and accurately filled

97 percent of taxpayers’ orders for forms and publications. However, these

indicators did not provide a complete assessment of the filing season and

masked several serious problems.

Specifically,

• IRS’ efforts to combat fraud, which resulted in over 7 million refunds being

delayed so that IRS could verify SSNs, generated much adverse publicity

that might have been alleviated if IRS had better forewarned taxpayers of

potential refund delays;

• our tests and IRS data showed that taxpayers continued to have serious

problems trying to reach IRS by telephone; and

• a new document-imaging system did not perform as expected, leading to

increased return processing costs and lower-than-expected productivity.

We recommended that IRS, if it planned to continue validating SSNs and

delaying refunds in 1996, adjust its methodology for assessing refund

timeliness. We also recommended that after IRS develops a measure of the

accessibility of its telephone assistance, which IRS was working on at the

time of our review, it add that measure to its key filing season

performance indicators.

Tax Administration: Electronic Filing Falling Short of

Expectations (GAO/GGD-96-12, Oct. 31, 1995). Electronic filing is a

cornerstone of IRS’ plan to move away from the traditional filing of paper

returns. IRS established a goal of receiving 80 million tax returns

electronically in 2001. In a report to the Ranking Minority Member of the

Senate Committee on Governmental Affairs, we discussed

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• IRS’ progress in broadening the use of electronic filing,

• the availability of data needed to develop an electronic filing strategy, and

• the implications for IRS if it does not significantly reduce its

paper-processing workload.

From 1992 through 1994, the number of returns filed electronically grew

from 12.6 million to 16.4 million, an annual growth rate of 14 percent. In

1995, the number of electronic returns was expected to drop to about

14.8 million, which IRS attributed to various actions it took to crack down

on refund fraud. Assuming 1995 was an aberration and the 14 percent

annual growth rate of the preceding years resumed, we estimated that only

about 33 million returns would be filed electronically by 2001.

A major impediment to the expansion of electronic filing is its cost to the

public. Taxpayers who file an electronic return through a preparer or

electronic filing transmitter have to pay as much as $40 for these services.

One aspect of IRS’ current electronic filing program that contributes to its

cost (not only to the public but also to IRS) is the need for taxpayers to

submit a paper signature document to affirm that information on the

electronic return is accurate.

Most of the electronic returns IRS received in 1994 were individual income

tax returns that could have been filed on Form 1040A or 1040EZ—forms

that are among the least costly paper returns to process. In addition, IRS

had made little headway in increasing the number of electronically filed

business returns, which are generally more complex and thus more costly

to process on paper than individual returns. The fact that less complex

returns comprise a disproportionate share of electronic filing may be, at

least in part, because of IRS’ goal of 80 million returns. Focusing on that

goal could cause IRS to target its efforts at groups of taxpayers or types of

returns that will boost the number of electronic returns but not necessarily

yield the greatest reductions in IRS’ paper-processing workload and

operating costs.

Although IRS has some comparative data on the cost to process electronic

and paper returns, it does not have comparative data on other costs, such

as storage and retrieval, that can vary depending on how a return is filed.

IRS also does not have

• adequate data on why taxpayers do not file electronically and what it

would take to get them to do so and

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• estimates of the number of electronic returns IRS can expect to receive

from those taxpayers after some market intervention.

Without a significant increase in electronic filing, IRS’ customer service and

paper-processing workloads may overwhelm its planned staffing and

require changes to various aspects of its modernization efforts. IRS did not

have contingency plans for that eventuality.

We recommended that IRS (1) identify those groups of taxpayers who offer

the greatest opportunity to reduce IRS’ paper-processing workload and

operating costs if they were to file electronically and (2) develop strategies

that seek to eliminate impediments that inhibit those groups from filing

electronically. We also recommended that IRS adopt electronic filing goals

that focus on reducing IRS’ paper-processing workload and operating costs

and prepare contingency plans for the possibility that electronic filings

will fall short of expectations.

Accounts Receivable/

Collections

IRS Tax Collection Reengineering (GAO/GGD-96-161R, Sept. 24, 1996). In a

letter to the Chairman, Senate Committee on Finance, we provided

information on IRS’ efforts to reengineer its enforcement action program,

which included the delinquent tax collection process.

The enforcement action reengineering effort started in June 1994 and was

suspended in November 1995. When the effort was suspended, few results

had been achieved in changing work processes or addressing IRS’

long-standing collection problems. An independent consultant’s report

identified several factors that hampered the reengineering effort: IRS did

not (1) have the organizational commitment and support needed to

achieve the level of change desired, (2) fully implement the reengineering

methodology needed, and (3) integrate its reengineering efforts with the

existing systems modernization program.

In October 1995, IRS established a separate office to coordinate all future

strategic change initiatives, like reengineering. In January 1996, IRS

announced plans to initiate a new reengineering project focusing on the

tax settlement process, which was expected to include aspects of

enforcement action and the tax collection processes.

IRS had also undertaken several projects to change the role of revenue

officers in the collection process by modernizing their jobs. One project,

for example, was to automate many manual work processes and link

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revenue officers to IRS’ computer databases through the use of laptop

computers.

Tax Administration: IRS Tax Debt Collection Practices

(GAO/T-GGD-96-112, Apr. 25, 1996). IRS confronts major hurdles in collecting

tens of billions of dollars in delinquent taxes. As Congress tries to balance

the federal budget, these unpaid taxes have become increasingly

important as have IRS’ collection efforts. We discussed IRS’ tax debt

collection practices before the Subcommittee on Oversight, House

Committee on Ways and Means.

We expressed the belief that IRS could do more to improve its collection

practices. The challenges facing IRS’ improvement efforts include

• a lack of accurate and reliable information on either the makeup of its

accounts receivable or the effectiveness of the collection tools and

programs it uses,

• an aged inventory of receivables,

• outdated collection processes, and

• antiquated technology.

IRS is attempting to modernize its information and processing systems, but

these actions will not be completed for several years. Without reliable

information on the accounts they are trying to collect and the taxpayers

who owe the debts, IRS employees generally do not know whether they are

resolving cases in the most efficient and effective manner and may spend

time pursuing invalid or unproductive cases. This lack of reliable

performance data also affects IRS’ ability to target its collection efforts to

specific taxpayers or types of debts. IRS needs a comprehensive strategy to

guide its efforts to improve tax debt collections, starting with having

accurate and reliable information.

We recommended in May 1993 that IRS test the use of private debt

collectors to support its collection efforts.10 Such a test could provide

useful insight into the effectiveness of the techniques and technologies

used in the private sector to collect older accounts. For example, IRS could

learn which actions are most productive based on the type of case, type of

taxpayer, and age of the account.

10See New Delinquent Tax Collection Methods for IRS (GAO/GGD-93-67, May 11, 1993).

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Tax Expenditures and

Preferences

Insular Areas Update (GAO/GGD-96-184R, Sept. 13, 1996). In a letter to the

Chairman, Senate Committee on Energy and Natural Resources, we

provided information on the fiscal arrangements between the U.S.

government and American Samoa, Guam, the Commonwealth of the

Northern Mariana Islands, the Commonwealth of Puerto Rico, and the U.S.

Virgin Islands. The letter updated information presented in our 1995

testimony.11

Since our 1995 testimony, the only significant change in how federal taxes

apply to the territories related to the Puerto Rico and possessions tax

credit—the tax credit was repealed, although existing claimants may

continue to earn credits during a 10-year transition period. We also

reported the following information for fiscal year 1995:

• IRS collected $3.3 billion from Puerto Rico for individual and corporation

income taxes, unemployment taxes, estate and gift taxes, and excise taxes.

• The Bureau of Alcohol, Tobacco, and Firearms collected $232.4 million in

excise taxes on rum shipped from Puerto Rico to the United States and

$47.8 million on rum shipped from the U.S. Virgin Islands to the United

States. The Treasury transferred $204.9 million and $41.7 million in rum

excise tax revenue to the governments of Puerto Rico and the U.S. Virgin

Islands, respectively.

• The Customs Service collected $138.2 million in duties in Puerto Rico, of

which $96 million was transferred to the Puerto Rican government.

Customs also collected $9.2 million in duties in the U.S. Virgin Islands, of

which $4.2 million was transferred to the U.S. Virgin Islands government.

• Federal expenditures in the five territories totaled $11.4 billion. The

expenditures included grants and other payments to the territorial

governments as well as salaries and wages for federal employees.

Profile of Indian Gaming (GAO/GGD-96-148R, Aug. 20, 1996). In a letter to

the Chairman, House Committee on Ways and Means, we provided

information on the Indian gaming industry. As of July 1996, according to

data from the National Indian Gaming Commission, 177 of the 557

officially recognized Indian tribes were operating 240 gaming facilities. An

additional 41 tribes had authorization to operate but had not yet opened

their gaming facilities. The 85 tribes that had filed financial statements for

either 1994 or 1995 reported about $3.5 billion in total gaming revenues

(defined as dollars wagered minus payouts) for 110 gaming facilities. Of

the 110 facilities, the 6 largest accounted for 40 percent of the revenues.

11U.S. Insular Areas: Information on Fiscal Relations With the Federal Government (GAO/T-GGD-95-71,

Jan. 31, 1995).

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On the basis of our analysis of the financial statements, we determined

that about $1.2 billion had been transferred from gaming facilities to 74 of

the 85 tribes.

Tax Policy: Analysis of Certain Potential Effects of Extending

Federal Income Taxation to Puerto Rico (GAO/GGD-96-127, Aug. 15, 1996).

In response to a request from the Chairman of the House Committee on

Resources and the Chairman of its Subcommittee on Native American and

Insular Affairs, we provided information on some potential effects of

extending the IRC to residents of the Commonwealth of Puerto Rico. Our

estimates relating to federal tax liabilities were based on the income and

demographic characteristics of Puerto Rican taxpayers in 1992, the latest

year for which detailed data were available.

If IRC tax rules had been applied to residents of Puerto Rico and if there

were no behavioral responses to this, the residents would have owed

around $623 million in federal income tax before taking into account the

EIC. The total amount of EIC would have been about $574 million, leaving a

net aggregate federal tax liability of about $49 million. We estimated that

about 59 percent of the population who filed individual income tax returns

in 1992 would have earned some EIC. The average EIC earned by eligible

taxpayers would have been $1,494.

We estimated that 41 percent of the households filing income tax returns

would have had positive federal income tax liabilities, 53 percent would

have received net transfers from the federal government because their EIC

would have more than offset their precredit liabilities, and 6 percent

would have had no federal tax liability.

If application of federal income tax resulted in an additional $49 million in

tax liability after subtracting EIC as we estimated and if the Puerto Rican

government wanted to keep constant the aggregate amount of combined

federal and Puerto Rican individual income tax levied on its residents, it

would have had to reduce its individual income tax revenue by about

5 percent.

We also accounted for the probability that some Puerto Rican residents

who were not required to file Puerto Rican tax returns in 1992 would file

federal tax returns because they qualified for the EIC. We estimated, as an

upper limit, that those additional EIC claims could total about $64 million,

and we discussed how additional EIC claims in that amount would affect

the data discussed above.

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Program Expenses of Charities (GAO/GGD-96-125R, July 10, 1996). In a

letter to Senator Daniel R. Coats, we provided information on program

service expenses reported by organizations that are exempt from taxation

under IRC 501(c)(3). These organizations are collectively known as

charities. Program service expenses are those expenses directly related to

the exempt purposes of the organization. Analysis of the organizational

expense data was based on information collected by IRS from the long

Form 990 returns filed by 121,627 charitable organizations that reported

expenses.

We estimated that the percentage of expenses allocated to program

services for those organizations that filed was about 86 percent of total

expenses for 1992. As a percentage of their total expenses, more than

60 percent of these charitable organizations had program service expenses

of 80 percent or greater.

Earned Income Credit: Profile of Tax Year 1994 Credit Recipients

(GAO/GGD-96-122BR, June 13, 1996). At the request of the Chairman, Senate

Committee on Finance, we provided information on participation in the

EIC program for tax years 1990 to 1994 and the characteristics of taxpayers

who received the credit in tax year 1994.

Total EIC program costs increased 150 percent from 1990 to 1994, and the

number of EIC recipients increased by about 50 percent, to 19.1 million.

Extension of the EIC to certain childless adults in 1994 was the main reason

for the recent growth in the number of EIC claimants. In tax year 1994,

about 15 million families with children received $20.5 billion in EIC while

4 million childless adults received EIC totaling $700 million.

Most of the taxpayers claiming the EIC for families with children filed as

heads of households, and nearly 90 percent of childless adult claimants

were single. The majority of EIC claimants were 25 to 44 years old, and in

tax year 1994, 1.2 million EIC recipients also claimed $507 million in child

and dependent care credits. EIC recipients, compared with filers who did

not claim EIC, were more likely to file their returns electronically, use

simpler tax forms, and use a tax preparer. EIC recipients derived their

income primarily from earnings rather than investment income. EIC is

structured so that the credit amount increases as income increases,

plateaus at a maximum credit amount, and then phases out as income

exceeds a certain amount. About 60 percent of taxpayers claiming EIC for

families with children had income in the credit’s phase-out range.

Page 45 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

In 1995, Congress enacted an indirect wealth test to eliminate from the EIC

program taxpayers with investment income over $2,350. If that investment

income threshold had been in place in tax year 1994, about 284,000

taxpayers, who had claimed $212 million of EIC, would not have been able

to do so.

Tax Policy and Administration: Review of Studies of the

Effectiveness of the Research Tax Credit (GAO/GGD-96-43, May 21, 1996).

During a congressional hearing in 1995, we were asked to evaluate recent

studies of the research tax credit to determine whether the evidence was

adequate to conclude that available evidence suggests that each dollar

taken of the research tax credit stimulates at least one dollar of research

spending in the short run and about two dollars of research spending in

the long run.12 In response to a request from Representative Robert T.

Matsui, we reviewed eight studies of the research tax credit, focusing on

• the adequacy of the studies’ data and methods to determine the amount of

research spending stimulated per dollar of foregone tax revenue and

• other factors that determine the credit’s value to society.

We found that four studies supported the claim that, during the 1980s, the

research credit stimulated research spending that exceeded its revenue

cost, but the other four studies did not support the claim or were

inconclusive. All of the studies had significant data and methodological

limitations that made it difficult to evaluate industry’s true responsiveness

to the research tax credit. Because the authors did not have access to

confidential tax return data, they used publicly available data to determine

the credit’s incentive. Public data were not a suitable substitute for tax

return data because public data used different definitions of taxable

income and research spending. Furthermore, the studies’ analytical

methods, such as use of industry aggregates and failure to incorporate

important tax code interactions, made their findings imprecise and

uncertain. We also found little research on the latest design of the credit to

determine its effect on incentives and costs.

As a result, the studies’ evidence was not adequate to conclude that a

dollar of research tax credit would stimulate a dollar of additional

short-term research spending or about two dollars of additional long-term

research spending. Moreover, the value of the research tax credit to

society cannot be determined simply by comparing the amount of research

12The May 10, 1995, hearing was held by the Subcommittee on Oversight, House Ways and Means

Committee.

Page 46 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

spending stimulated by the credit versus the credit’s revenue cost. A

comparison would have to be made between the total benefits gained by

society from research stimulated by the credit and the estimated costs to

society resulting from the collection of taxes required to fund the credit.

Budget Issues: Selected GAO Work on Federal Financial Support of

Business (GAO/AIMD/GGD-96-87, Mar. 7, 1996). The federal government

provides financial benefits to businesses as a way to fulfill a wide range of

public policy goals. At the request of Representative Charles F. Bass, we

summarized our previously issued work on spending programs and tax

benefits available to businesses. Our work showed that these benefits are

spread throughout the budget, including programs in international affairs,

energy, natural resources and environment, agriculture, and

transportation. In cases where programs are poorly designed, including

those benefiting businesses, the federal government may spend more

money or lose more revenue than needed to reach its intended audience

and achieve program or service goals.

The problems with these financial support programs can be grouped into

several categories:

• ineffective or inefficient transfers, wherein some businesses receive

federal funds or tax benefits to do things they would have done anyway;

• preemption of market forces, wherein artificially increasing the price of

goods to consumers can encourage inefficient production and increase

costs;

• moral hazards, wherein federal programs provide incentives to businesses

to undertake more, risky activities than they would without the program;

and

• duplication and working at cross-purposes, wherein several federal

programs address the same problem or where one program may

counteract the beneficial effects of another program.

Tax Consequences of Offsets (GAO/NSIAD-96-74R, Dec. 22, 1995). In a letter

to the Chairmen and Ranking Minority Members of the Senate Committee

on Armed Services, Senate Committee on Veterans’ Affairs, House

Committee on National Security, and House Committee on Veterans’

Affairs, we provided information on the tax consequences to veterans of

the required offset of certain types of Department of Defense (DOD)

separation pay and Department of Veterans Affairs (VA) disability

compensation.

Page 47 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

In 1980, Congress authorized DOD to provide lump-sum separation pay to

service members for involuntary separation. In 1991, to assist DOD in

downsizing, Congress authorized DOD to pay a higher level of lump-sum

separation pay or an annual annuity to those who separate voluntarily.

After separating, some veterans qualify for service-connected disability

compensation from VA. Federal income taxes are withheld from separation

pay. Disability compensation is tax-exempt. Federal law requires the

recoupment of the gross amount of separation pay (known as an offset)

from those who also receive disability compensation for the same period

of service.

We were asked if separation pay could be reclassified as disability

compensation for tax purposes and whether veterans could deduct

recouped separation pay from gross income. According to IRS, veterans

may not reclassify separation pay as disability compensation and may not

deduct recouped separation pay from gross income. IRS did conclude,

however, that in one limited situation, veterans may retroactively exclude

part of their lump-sum separation pay from gross income if they also

qualify for disability compensation.

Tax Exempt (GAO/GGD-96-47R, Nov. 8, 1995; GAO/GGD-96-46R, Nov. 8, 1995; and

GAO/GGD-96-29R, Oct. 10, 1995). In November 8, 1995, letters to

Representatives Ernest Istook and David M. McIntosh, we analyzed IRS

Statistics of Income data for certain tax exempt organizations. We noted

that these data were limited in that they

• covered grants from all levels of government, not just the federal

government and

• did not include all federal grants received by exempt organizations.

For Representative Istook, we provided information on grant receipts,

lobbying expenditures, and political expenditures for certain organizations

that were exempt from tax under IRC sections 501(c)(3) through 501(c)(9).

IRS data showed that there were 259,502 organizations exempt under those

code sections of which 44,274 reported receiving government grants

totaling about $42.6 million. Of those organizations receiving grants, 1,029

reported lobbying expenditures totaling about $43.2 million, and 41

reported political expenditures totaling about $2.4 billion.

For Representative McIntosh, we compared the average lobbying

expenditures for tax-exempt charitable organizations that received

government grants with the average expenditures for charities that did not

Page 48 GAO/GGD-97-122 1996 Annual Tax Report
Appendix I 

Summaries of Tax-Related Products Issued

in Fiscal Year 1996

receive government grants in tax year 1992. IRS data showed that out of

122,563 charities, 2,132 reported lobbying expenditures that totaled about

$75.9 million for tax year 1992. Of the organizations that reported lobbying

expenditures, 48 percent reported receiving government grants. Grantees

reported average lobbying expenditures of about $41,940 per organization,

and nongrantees reported average lobbying expenditures of about $29,701

per organization.

In an October 10, 1995, letter to Representative Ernest Istook, we reviewed

the methodology used by Dr. William Duncan to prepare his analysis

entitled Non-Profit Lobbying Statistics. In his analysis, Dr. Duncan

attempted to quantify the lobbying expenditures of 501(c)(3) organizations

that received government grants in tax year 1992. We noted that his

approach should produce reasonably accurate results if the methodology

he described to us was applied to the data he identified.

Other Summary of Selected GAO Reports (GAO/GGD-96-193R, Sept. 26, 1996). In a

letter to the Co-Chairmen, National Commission on Restructuring the

Internal Revenue Service, we summarized selected GAO reports about IRS

that were issued in fiscal years 1991 through 1995 and in the first three

quarters of fiscal year 1996. We noted that the reports

• identified areas that are particularly problematic to IRS, such as tax return

processing, customer service, collection efforts, financial management,

and information technology and

• indicated the formidable challenges IRS faces in making its organization,

operations, and processes more effective and efficient while improving

service to taxpayers.

Tax Policy and Administration: 1995 Annual Report on GAO’s

Tax-Related Work (GAO/GGD-96-61, Mar. 8, 1996). Pursuant to a legislative

requirement, we summarized our work on tax policy and administration

during fiscal year 1995. This report highlights notable reports and

testimony from fiscal year 1995, discusses actions taken on our

recommendations as of the end of 1995, discusses recommendations that

we made to Congress before and during fiscal year 1995 that had not been

acted upon, and lists the assignments for which we were given access to

tax information under the law. Our key recommendations related to

improving compliance with the tax laws, better assisting taxpayers,

enhancing the effectiveness of tax incentives, improving IRS management,

and improving the processing of returns and receipts.

Page 49 GAO/GGD-97-122 1996 Annual Tax Report
Appendix II 

Chronological Listing of GAO Products on

Tax Matters Issued in Fiscal Year 1996

Report title and number Date issued

Tax Administration: Information on IRS’ Taxpayer Compliance

Measurement Program (GAO/GGD-96-21)

10/06/95

Tax Administration: IRS Faces Challenges in Reorganizing for

Customer Service (GAO/GGD-96-3)

10/10/95

Tax Exempt (GAO/GGD-96-29R) 10/10/95

Tax Administration: Audit Trends and Taxes Assessed on Large

Corporations (GAO/GGD-96-6)

10/13/95

Tax Administration: Electronic Filing Falling Short of Expectations

(GAO/GGD-96-12)

10/31/95

Tax Exempt (GAO/GGD-96-46R) 11/08/95

Tax Exempt (GAO/GGD-96-47R) 11/08/95

Tax Consequences of Offsets (GAO/NSIAD-96-74R) 12/22/95

The 1995 Tax Filing Season: IRS Performance Indicators Provide

Incomplete Information About Some Problems (GAO/GGD-96-48)

12/29/95

Tax Administration: Diesel Fuel Excise Tax Change

(GAO/GGD-96-53)

01/16/96

IRS Staffing Trends (GAO/GGD-96-73R) 01/31/96

IRS Operations: Significant Challenges in Financial Management

and Systems Modernization (GAO/T-AIMD-96-56)

03/06/96

Budget Issues: Selected GAO Work on Federal Financial Support

of Business (GAO/AIMD/GGD-96-87)

03/07/96

Tax Policy and Administration: 1995 Annual Report on GAO’s

Tax-Related Work (GAO/GGD-96-61)

03/08/96

Tax Administration: Making IRS’ Telephone Systems Easier to

Use Should Help Taxpayers (GAO/GGD-96-74)

03/11/96

Status of Tax Systems Modernization, Tax Delinquencies, and the

Potential for Return-Free Filing (GAO/T-GGD/AIMD-96-88)

03/14/96

Tax Administration: IRS Can Improve Information Reporting for

Original Issue Discount Bonds (GAO/GGD-96-70)

03/15/96

IRS Efforts to Control Fraud in 1995 (GAO/GGD-96-96R) 03/25/96

Tax Systems Modernization: Management and Technical

Weaknesses Must Be Overcome to Achieve Success

(GAO/T-AIMD-96-75)

03/26/96

Tax Administration: IRS’ Fiscal Year 1996 and 1997 Budget

Issues and the 1996 Filing Season (GAO/T-GGD-96-99)

03/28/96

Tax System: Issues in Tax Compliance Burden

(GAO/T-GGD-96-100)

04/03/96

Tax Administration: IRS Tax Debt Collection Practices

(GAO/T-GGD-96-112)

04/25/96

Tax Administration: Audit Trends and Results for Individual

Taxpayers (GAO/GGD-96-91)

04/26/96

Tax Administration: Alternative Strategies to Obtain Compliance

Data (GAO/GGD-96-89)

04/26/96

(continued)

Page 50 GAO/GGD-97-122 1996 Annual Tax Report
Appendix II 

Chronological Listing of GAO Products on

Tax Matters Issued in Fiscal Year 1996

Report title and number Date issued

Tax Systems Modernization: Progress in Achieving IRS’ Business

Vision (GAO/T-GGD-96-123)

05/09/96

Internal Revenue Service: Results of Nonfiler Strategy and

Opportunities to Improve Future Efforts (GAO/GGD-96-72)

05/13/96

Tax Policy and Administration: Review of Studies of the

Effectiveness of the Research Tax Credit (GAO/GGD-96-43)

05/21/96

Tax Research: IRS Has Made Progress But Major Challenges

Remain (GAO/GGD-96-109)

06/05/96

Financial Audit: Actions Needed to Improve IRS Financial

Management (GAO/T-AIMD-96-96)

06/06/96

Tax Systems Modernization: Actions Underway But IRS Has Not

Yet Corrected Management and Technical Weaknesses

(GAO/AIMD-96-106)

06/07/96

Earned Income Credit: Profile of Tax Year 1994 Credit Recipients

(GAO/GGD-96-122BR)

06/13/96

Tax Administration: Issues in Classifying Workers as Employees

or Independent Contractors (GAO/T-GGD-96-130)

06/20/96

Tax Refund Timeliness (GAO/GGD-96-131R) 06/26/96

Program Expenses of Charities (GAO/GGD-96-125R) 07/10/96

Financial Audit: Examination of IRS’ Fiscal Year 1995 Financial

Statements (GAO/AIMD-96-101)

07/11/96

Managing IRS: IRS Needs to Continue Improving Operations and

Service (GAO/T-GGD/AIMD-96-170)

07/29/96

Tax Policy: Analysis of Certain Potential Effects of Extending

Federal Income Taxation to Puerto Rico (GAO/GGD-96-127)

08/15/96

Profile of Indian Gaming (GAO/GGD-96-148R) 08/20/96

Tax Systems Modernization: Cyberfile Project Was Poorly

Planned and Managed (GAO/AIMD-96-140)

08/26/96

Tax Administration: Tax Compliance of Nonwage Earners

(GAO/GGD-96-165)

08/28/96

Tax Administration: IRS Is Improving Its Controls for Ensuring

That Taxpayers Are Treated Properly (GAO/GGD-96-176)

08/30/96

Tax Administration: Income Tax Treatment of Married and Single

Individuals (GAO/GGD-96-175)

09/03/96

Internal Revenue Service: Business Operations Need Continued

Improvement (GAO/AIMD/GGD-96-152)

09/09/96

IRS Operations: Critical Need to Continue Improving Core

Business Practices (GAO/T-AIMD/GGD-96-188)

09/10/96

Tax Systems Modernization: Actions Underway But Management

and Technical Weaknesses Not Yet Corrected

(GAO/T-AIMD-96-165)

09/10/96

Insular Areas Update (GAO/GGD-96-184R) 09/13/96

Earned Income Credit: IRS’ 1995 Controls Stopped Some

Noncompliance, But Not Without Problems (GAO/GGD-96-172)

09/18/96

(continued)

Page 51 GAO/GGD-97-122 1996 Annual Tax Report
Appendix II 

Chronological Listing of GAO Products on

Tax Matters Issued in Fiscal Year 1996

Report title and number Date issued

IRS Financial Audits: Status of Efforts to Resolve Financial

Management Weaknesses (GAO/T-AIMD-96-170)

09/19/96

IRS Tax Collection Reengineering (GAO/GGD-96-161R) 09/24/96

Summary of Selected GAO Reports (GAO/GGD-96-193R) 09/26/96

Page 52 GAO/GGD-97-122 1996 Annual Tax Report
Appendix III 

Major Contributors to This Report

General Government

Division, Washington,

D.C.

David J. Attianese, Assistant Director

Charles W. Woodward III, Evaluator-in-Charge

Elizabeth W. Scullin, Communications Analyst

(268775) Page 53 GAO/GGD-97-122 1996 Annual Tax Report
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