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[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]

 
 2002 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2003
=======================================================================

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED SEVENTH CONGRESS

                             SECOND SESSION
                               __________

                             APRIL 9, 2002
                               __________

                           Serial No. 107-61
                               __________

         Printed for the use of the Committee on Ways and Means

                     U.S. GOVERNMENT PRINTING OFFICE
79-436                       WASHINGTON : 2002
________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpr.gov  Phone: toll free (866) 512-1800; (202) 512�091800  
Fax: (202) 512�092250 Mail: Stop SSOP, Washington, DC 20402�090001

                      COMMITTEE ON WAYS AND MEANS

                   BILL THOMAS, California, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida           FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut        ROBERT T. MATSUI, California
AMO HOUGHTON, New York               WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California             SANDER M. LEVIN, Michigan
JIM McCRERY, Louisiana               BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan                  JIM McDERMOTT, Washington
JIM RAMSTAD, Minnesota               GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa                     JOHN LEWIS, Georgia
SAM JOHNSON, Texas                   RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington            MICHAEL R. McNULTY, New York
MAC COLLINS, Georgia                 WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio                    JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania           XAVIER BECERRA, California
WES WATKINS, Oklahoma                KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona               LLOYD DOGGETT, Texas
JERRY WELLER, Illinois               EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin

                     Allison Giles, Chief of Staff
                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JERRY WELLER, Illinois               MICHAEL R. McNULTY, New York
KENNY C. HULSHOF, Missouri           JOHN LEWIS, Georgia
SCOTT McINNIS, Colorado              KAREN L. THURMAN, Florida
MARK FOLEY, Florida                  EARL POMEROY, North Dakota
SAM JOHNSON, Texas
JENNIFER DUNN, Washington

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.

                            C O N T E N T S

                               __________
                                                                   Page
Advisory of March 28, 2002, announcing the hearing...............     2

                               WITNESSES

Internal Revenue Service, Hon. Charles O. Rossotti, Commissioner.     6
U.S. General Accounting Office, James R. White, Director, Tax 
  Issues.........................................................    40

                                 ______

American Institute of Certified Public Accountants, James A. 
  Dougherty......................................................    66
H&R Block, Inc.:
    Mark A. Ernst................................................    71
    Robert Weinberger............................................    86
National Association of Enrolled Agents, and Padgett Business 
  Service, Roger Harris..........................................    80
National Society of Accountants, and National Tax Consultants, 
  William Stevenson..............................................    86
National Treasury Employees Union, Colleen M. Kelley.............    55

                       SUBMISSION FOR THE RECORD

Kole, Karen, Valparaiso University School of Law Tax Clinic, 
  Valparaiso, Indiana, letter....................................    97

 2002 TAX RETURN FILING SEASON AND THE IRS BUDGET FOR FISCAL YEAR 2003

                              ----------                              

                         Tuesday, April 9, 2002

                  House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.

    The Subcommittee met, pursuant to notice, at 2:05 p.m., in 
room 1100 Longworth House Office Building, Hon. Amo Houghton 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE 
COMMITTEE
 ON WAYS 
AND 
MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE
March 28, 2002
No. OV-10

                   Houghton Announces Hearing on the

                 2002 Tax Return Filing Season and the

                    IRS Budget for Fiscal Year 2003

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced that the 
Subcommittee will hold a hearing on the 2002 tax return filing season 
and the Administration's budget request for the Internal Revenue 
Service (IRS) for fiscal year 2003. The hearing will take place on 
Tuesday, April 9, 2002, in the main Committee hearing room, 1100 
Longworth House Office Building, beginning at 2:00 p.m.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. 
Witnesses will include IRS Commissioner Charles Rossotti, James White, 
Director of Tax Administration and Justice Issues, U.S. General 
Accounting Office, as well as representatives of the National Treasury 
Employees Union and groups involved in tax preparation. However, any 
individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    The 2002 tax return filing season refers to the period from January 
1st to April 15th when U.S. taxpayers will file more than 137 million 
tax returns, including 44.9 million e-filed returns. During this period 
the IRS is expected to issue over 100 million tax refunds, answer 108 
million telephone calls from taxpayers asking for assistance, and its 
homepage will receive 3 billion hits.
      
    The Administration's budget requests $10.4 billion to fund the IRS 
for fiscal year 2003. This level of funding will support approximately 
101,000 employees who will collect about $1.9 trillion in taxes, 
according to Administration estimates.
      
    Beyond supporting the traditional activities of the filing season, 
the fiscal year 2003 budget request addresses three key strategic goals 
by the Administration, including pre-filing assistance, filing 
assistance, and taxpayer compliance programs. The budget request also 
includes $450 million for the continued Business Systems Modernization 
effort, as well as $154 million for the Earned Income Tax Credit 
Compliance Initiative. The Business Systems Modernization effort is a 
continuation of the program initiated by the landmark IRS Restructuring 
and Reform Act of 1998 (P.L. 105-206).
      
    In announcing the hearing, Chairman Houghton stated: ``Improved 
customer service was the promise of the new IRS after the Restructuring 
and Reform Act of 1998. This hearing gives us the opportunity to ensure 
that the IRS is living up to its promise by processing taxpayer 
questions, returns, and refunds as efficiently as possible. I am 
looking forward to our annual review of the tax filing season and the 
IRS budget.''
      

FOCUS OF THE HEARING:

      
    The Subcommittee will review developments in the 2002 tax filing 
season, including progress in the customer communications system, 
electronic filing, and systems modernization. In addition, the 
Subcommittee will review the proposed budget for the IRS for fiscal 
year 2003.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Due to the change in House mail policy, any person or 
organization wishing to submit a written statement for the printed 
record of the hearing should send it electronically to 
[email protected], along with a fax copy to 
(202) 225-2610 by the close of business, Tuesday, April 23, 2002. Those 
filing written statements who wish to have their statements distributed 
to the press and interested public at the hearing should deliver their 
200 copies to the Subcommittee on Oversight in room 1136 Longworth 
House Office Building, in an open and searchable package 48 hours 
before the hearing. The U.S. Capitol Police will refuse sealed-packaged 
deliveries to all House Office Buildings. Failure to do so may result 
in the witness being denied the opportunity to testify in person.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. Due to the change in House mail policy, all statements and any 
accompanying exhibits for printing must be submitted electronically to 
[email protected], along with a fax copy to 
(202) 225-2610, in Word Perfect or MS Word format and MUST NOT exceed a 
total of 10 pages including attachments. Witnesses are advised that the 
Committee will rely on electronic submissions for printing the official 
hearing record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://waysandmeans.house.gov.
      
    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call (202) 225-1721 or (202) 226-3411 TTD/TTY in advance of the event 
(four business days notice is requested). Questions with regard to 
special accommodation needs in general (including availability of 
Committee materials in alternative formats) may be directed to the 
Committee as noted above.

                                

    Chairman Houghton. Good afternoon, ladies and gentlemen.
    Good afternoon, Commissioner, glad to see you here.
    Let me make an opening statement first, and then I will ask 
anyone else if they have an opening statement, particularly Mr. 
Coyne.
    As we all know, voluntary compliance is the foundation of 
our tax system. I cannot tell you how troubled I am about 
recent reports that show an erosion of trust in its fairness. 
This apparent erosion coincides with the persistent decline in 
enforcement statistics. The percentage of taxpayers who are 
audited has declined, and some say tax professionals can no 
longer convince clients to fear the Internal Revenue Service 
(IRS). One tax adviser has taken to posing a depiction of 
heaven and hell on her wall to supply the fortitude that fear 
of an IRS audit once supplied.
    I don't want to add to this problem by failing to observe 
that the vast majority of taxpayers are indeed honest and 
comply faithfully and with great integrity. But we do need to 
address this problem, and I will ask each of our witnesses 
today what we can do to turn the situation around.
    Our witnesses have specific knowledge or experience with 
different aspects of IRS operations. In addition to sharing 
their views on tax compliance, they will focus on the 2002 
filing season, the President's budget request, and also current 
developments at the IRS.
    Despite the progress of the IRS is making in customer 
service, as highlighted in the Commissioner's testimony, there 
is still troubling reports that IRS performance is lagging in 
some areas. For example, taxpayers continue to complain about 
various aspects of the Offer in Compromise Program, and 
independent reviewers have expressed concerns about the quality 
of telephone assistance and walk-in assistance to taxpayers.
    On the other hand, the IRS appears to be doing better this 
year to encourage electronic filing and a whole variety of 
other things.
    On Wednesday, I hope, the House is scheduled to consider 
the Taxpayer Protection and IRS Accountability Act of 2002, 
legislation that some of us have sponsored. Commissioner 
Rossotti played an important role in advocating the 
modification we are making to the so-called 10 deadly sins--I 
guess there are 11 of them now--provisions of the 1998 IRS 
Restructuring Act; and the President, in his budget request, 
proposed a 15-day extension for electronic filers that we are 
adopting. I hope that that 15-day extension will further 
accelerate the pace of electronic filing and that the change of 
the 10 deadly sins improves morale at the IRS while continuing 
to protect taxpayers from arbitrary and unlawful conduct.
    Additionally, I would like to note that the Administration 
will be submitting to Congress a series of recommendations on 
individual tax simplification in the next several weeks. I look 
forward to reviewing those recommendations, and I hope we can 
act on them in the near future.
    Now, let me turn to Commissioner Rossotti for a moment. The 
Commissioner has transformed the IRS. He has transformed it 
from an outdated structure based on geography into a modern 
customer-focused agency organized around the tax needs of 
American citizens. He has also laid the groundwork for 
technological change that will carry the IRS into the 21st 
century. We are just beginning to see the fruits of those 
innovations today. For example, the electronic funds transfer 
payment system has greatly simplified payroll taxes.
    I understand, sir, that your term will expire in November 
and that you have announced your intention to move back to the 
private sector. I want to thank you on behalf of all of us for 
your exemplary public service; and I wish you success, 
obviously, in reentering the private sector.
    I am pleased now to yield to our Ranking Democrat, Mr. 
Coyne.
    [The opening statement of Chairman Houghton follows:]
    Opening Statement of the Hon. Amo Houghton, a Representative in 
  Congress from the State of New York, and Chairman, Subcommittee on 
                               Oversight
    Good afternoon. Voluntary compliance is the foundation of our tax 
system, and I can't tell you how troubled I am about recent reports 
that show an erosion of trust in its fairness. This apparent erosion 
coincides with a persistent decline in enforcement statistics; the 
percentage of taxpayers who are audited has declined, and some tax 
professionals say they can no longer convince clients to fear the IRS. 
One tax advisor has taken to posting a depiction of heaven and hell on 
her wall to supply the fortitude that fear of an IRS audit once 
supplied.
    I don't want to add to this problem by failing to observe that the 
vast majority of taxpayers are indeed honest and comply faithfully and 
with great integrity, but we need to address the problem. I will ask 
each of our witnesses today what we can do to turn this situation 
around.
    Our witnesses have specific knowledge or experience with different 
aspects of IRS operations. In addition to sharing their views on tax 
compliance, they will focus on the 2002 filing season, the President's 
budget request, and current developments at the IRS.
    Despite the progress the IRS is making in customer service, as 
highlighted in the Commissioner's testimony, there are still troubling 
reports that IRS performance is lagging in some areas. For example, 
taxpayers continue to complain about various aspects of the offer in 
compromise program, and independent reviewers have expressed concerns 
about the quality of telephone assistance and walk-in assistance to 
taxpayers. On the other hand, the IRS appears to be doing better this 
year to encourage electronic filing.
    On Wednesday, the House is scheduled to consider the Taxpayer 
Protection and IRS Accountability Act of 2002, legislation that I 
sponsored. Commissioner Rossotti played an important role in advocating 
the modification we are making to the so-called ``Ten Deadly Sins'' 
provision of the 1998 IRS Restructuring Act, and the President, in his 
budget request, proposed a 15 day extension for electronic filers that 
we are adopting. I hope that the 15 day extension further accelerates 
the pace of electronic filing, and that the change to the Ten Deadly 
Sins improves morale at the IRS while continuing to protect taxpayers 
from arbitrary and unlawful conduct.
    Additionally, I note that the Administration will be submitting to 
Congress a series of recommendations on individual tax simplification 
in the next several weeks. I look forward to reviewing those 
recommendations, and I hope we can act on them in the near future.
    During his tenure, Commissioner Rossotti has transformed the IRS 
from an outdated structure, based on geography, into a modern, 
customer-focused agency organized around the tax needs of American 
citizens. He has also laid the groundwork for technological changes 
that will carry the IRS far into the 21st century. We are just 
beginning to see the fruits of those innovations today, for example, in 
the Electronic Funds Transfer Payment System that has greatly 
simplified the remittance of payroll taxes. I understand your term will 
expire in November and that you have announced your intention to move 
back to the private sector. Thank you, Commissioner, for your exemplary 
public service, and I wish you success in your future endeavors.
    I am pleased to yield to our ranking Democrat, Mr. Coyne.

                                

    Mr. Coyne. Thank you, Mr. Chairman.
    Once again this year, the Subcommittee on Oversight is 
holding a hearing on the current tax return filing season and 
the pending IRS budget. I thank Subcommittee Chairman Houghton 
for conducting this important annual oversight review of the 
Internal Revenue Service.
    More than 137 million tax returns will be filed during the 
2002 tax return filing season, which ends in 6 days from today. 
During the filing season, the IRS will issue over 100 million 
tax refunds and answer over 100 million telephone calls from 
taxpayers seeking assistance. I want to commend IRS 
Commissioner Rossotti and all IRS employees for a job well 
done.
    Of particular interest to this Subcommittee is the proposed 
budget for the IRS for the year 2003. The Administration's IRS 
request is $10.4 billion for funding general operations plus 
additional amounts to continue systems modernization and Earned 
Income Tax Credit (EITC) compliance initiatives. We need to 
make sure that such funding is adequate.
    I look forward to the views of the witnesses scheduled to 
testify before us here today. With Commissioner Rossotti, as 
the Chairman pointed out, planning to finish his term and leave 
the IRS at the end of the year, I would hope that we could use 
today's hearing to solicit his advice about what Congress needs 
to do to keep the IRS on track in implementing the IRS reform 
legislation 1998.
    I want to also commend the Commissioner on a job well done. 
His outstanding service as Commissioner of the IRS has set a 
high mark against which future commissioners will be judged. I 
want to thank Mr. Rossotti and wish him the best in his future 
endeavors.
    [The opening statement of Mr. Coyne follows:]
  Opening Statement of the Hon. William J. Coyne, a Representative in 
                Congress from the State of Pennsylvania
    Once again this year, the Subcommittee on Oversight is holding a 
hearing on the current tax return filing season and the pending IRS 
budget. I thank Subcommittee Chairman Houghton for conducting this 
important annual oversight review of the Internal Revenue Service.
    More than 137 million tax returns will be filed during the 2002 tax 
return filing season, which ends in six days. During the filing season, 
the IRS will issue over 100 million tax refunds and answer over 100 
million telephone calls from taxpayers seeking assistance. I want to 
commend IRS Commissioner Rossotti and all IRS employees for a job well 
done.
    Of particular interest to this Subcommittee is the proposed budget 
for the IRS for fiscal year 2003. The Administration's IRS request is 
$10.4 billion for funding general operations, plus additional amounts 
to continue systems modernization and earned income tax credit 
compliance initiatives. We need to make sure that such funding is 
adequate. I look forward to the views of the witnesses scheduled to 
testify before us today.
    With Commissioner Rossotti planning to finish his term and leave 
the IRS at the end of the year, I would hope that we could use today's 
hearing to solicit his advice about what the Congress needs to do to 
keep the IRS ``on track'' in implementing the IRS reform legislation of 
1998.
    I want to also commend the Commissioner on a job well done. His 
outstanding service as Commissioner of the IRS has set a high mark 
against which future Commissioners will be judged. I want to thank Mr. 
Rossotti and wish him the best in his future endeavors.

                                

    Chairman Houghton. Thank you very much, Mr. Coyne. Now, is 
there anyone else on the Committee who would like to make an 
opening statement?
    All right, Mr. Commissioner, you are on.

   STATEMENT OF THE HON. CHARLES O. ROSSOTTI, COMMISSIONER, 
                    INTERNAL REVENUE SERVICE

    Mr. Rossotti. Thank you very much. I want to thank you and 
Mr. Coyne for the kind comments you made about me. It has been 
a great honor coming before you each of these years and serving 
in this position, I can assure you of that.
    I will comment on the topic of the filing season and the 
budget, which is the scheduled topic, but I would be more than 
happy to come back and answer your questions about the 
compliance and enforcement issues during the hearing.
    I want to also say that I think the progress that we have 
made, which I think has been significant, has been in no small 
measure due to the support that you and your Committee have 
provided over this period; and in particular I want to thank 
Chairman Thomas as well as Congressmen Portman and Coyne for 
sponsoring the amendments that were made to the most recent 
act. We think those will be very, very helpful.
    I am pleased to report, with respect to the current filing 
season, that we are, I believe, improving performance across 
the board; and I think it is important to note that over the 
last few years our improvement in performance has been 
recognized by the most important judge of our performance, 
which is the American public. We are going to put up a chart 
here which just shows the trend in how the public thinks about 
the IRS, as measured by two very well respected surveys, one of 
which is the Roper Starch survey, which showed our rating, as 
you can see on that bottom line there, increasing in each of 
the last 3 years quite significantly, after regrettably 
reaching an all-time low in 1998.
    The top line is a more recent survey done by the University 
of Michigan, which also measures customer satisfaction for a 
number of agencies, in this case the IRS; and it showed the 
largest gain of any Federal agency in the last 2 years.
    I don't mean to put too much focus just on surveys, but I 
do believe that the public's rating of the IRS is fundamentally 
important to the health of a tax system. I really don't believe 
it is acceptable for a government agency that affects more 
Americans than any other institution to be also rated, as we 
were in 1998, as the lowest-rated institution that they deal 
with. Changing that rating, that point of view of the public, 
was one of the mandates of the restructuring act which the 
Congress passed; and I think, as noted here, we are beginning, 
but I do stress beginning, to deliver on that mandate. The 
trend is positive, but, as I will note, there is a lot more to 
be done.
    Turning to the specific details of the current filing 
season, it has been smooth, with returns being processed on 
time, electronic filing increasing substantially, and improved 
quality of phone service. So I think this demonstrates how we 
can build on positive trends for service to taxpayers, 
especially as our technology and organizational initiatives 
take effect.
    We have encountered a significant number of taxpayer errors 
concerning one particular item on the return having to do with 
the rate reduction credit, but despite encountering a number of 
these problems, about 6 percent of the returns are having this 
error, we have nevertheless been able to meet our schedules and 
get our refunds out in time. I actually view this as a clear 
demonstration of how our new organization enables us to respond 
rapidly, identify and fix problems which inevitably occur from 
time to time during the filing season.
    Chairman Houghton. Could I interrupt a minute? I know my 
eyes are old, but I cannot see that. Maybe if someone could 
sort of bring it up part way, in this lower level desk.
    Mr. Rossotti. I think we have copies of this, which we will 
provide for you.
    The basic idea is to show the trend lines, as opposed to 
any specific numbers on this chart. This chart shows some of 
the trends over the last 2 years on a number of the key 
indicators of service that taxpayers are receiving during the 
filing season, and of course it is during the filing season 
that most individual taxpayers do interact with the IRS.
    You will notice there is a couple of lines up there on the 
left which are literally going off the chart, and those reflect 
the use by taxpayers of our Web site, which is IRS.gov. In 
January, at the beginning of the season, we introduced the 
newly designed Web site, which was designed to be more 
accessible and easier to navigate for taxpayers, and that has 
helped the usage of this great resource really grow 
dramatically.
    What it means to taxpayers is that there is less time and 
effort getting the information they need to file their returns. 
They can get forms, for example, without having to make last-
minute trips down to the post office; and they can get 
information about almost any aspect of the tax system with just 
a few clicks on their home computer.
    The second line up there that is growing quite nicely is 
the growth in electronically filed individual returns. For this 
fiscal year, 2002, we set an aggressive goal of receiving 46 
million 1040 returns, which would be a 15-percent increase over 
last year; and I am pleased to say that, as of this time, we 
project we will even exceed the 46 million goal. As a matter of 
fact, as of yesterday, we actually already exceeded the total 
number of electronically filed returns that we received all 
year last year. So we are doing quite well.
    I want to note that the provision that this Committee 
reported out to extend the filing date and the paying date for 
those that file and pay electronically will be of great help in 
continuing, maybe even accelerating this trend which should 
help us reach the congressional goal of 80 percent filing by 
2007.
    There are some other charts on there that show both the 
quality and accessibility of phone service, which is the way 
that most taxpayers who need help get it during the filing 
season. And I want to show one other chart here, which just 
shows by month how many calls we were receiving and what the 
level of accessibility was. I think what you can see is that we 
had, as a result of the issues I mentioned about the rate 
reduction credit, a bump-up in demand well above what was 
expected during February, which did temporarily, for a few 
weeks, drive down our service. But we quickly recovered and we 
have now, since then, been reaching more than our goal of a 71-
percent level of access.
    I should also note that another measure that is important 
to taxpayers is how long they have to wait to get through. On 
tax law calls, for example, we were down to a 2.58-minute wait, 
which is down from 4.27 minutes last year. So we are making a 
significant improvement in making it faster for taxpayers to 
get through.
    The other very important dimension of our service, if you 
want to put the other chart back for this, is quality. It is 
very, very important that when taxpayers call in and ask a tax 
law question or ask us to update their account that it be done 
accurately. That is not an easy thing to do, given the 
complexity of the subject matter. There are a couple of those 
lines up there that you can see that reflect inequality of tax 
law and tax account service, and they, in particular, have 
improved substantially this year. For tax law and tax account 
questions we are up to 83 and 89 percent accuracy this year, as 
compared with 75 to 88 percent last year.
    I also should note that, since September 24, only 13 days 
after the September 11 attack, we established a special phone 
line for victims of the terrorist attacks, and we have provided 
over 90 percent service to taxpayers on that.
    So I think as we conclude the home stretch of this filing 
season, we do take pride in the improvement in the service that 
we have offered. But I also note that, while we are headed in 
the right direction, we are not at the end of the journey by 
any means. We still have a lot of work to do. We have improved 
service, but we were starting from a very low level, very 
honestly, as I noted at the beginning. And even now, a 71-
percent level, which is our goal for this year, and an 89 
percent accuracy rate does not meet our long-term standard of 
being as good as the private sector delivers.
    So the continuation of modernization, adequate funding for 
operations and our own internal aggressive performance 
improvement goals are all going to be necessary year by year in 
order to achieve ultimately the level of service that the 
public expects and that we aim to deliver. I do believe that if 
we stay focused on these goals and that we get consistent 
funding and support from the Congress, we can achieve them; and 
I believe the main point I want to make today is that we are on 
the path of doing that.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Rossotti follows:]
   Statement of the Hon. Charles O. Rossotti, Commissioner, Internal 
                            Revenue Service
INTRODUCTION
    Mr. Chairman, I thank you for this opportunity to testify before 
the Subcommittee on the 2002 tax filing season, our FY 2003 budget 
request and some of the initiatives we are undertaking on behalf of 
America's taxpayers.
    On a personal note, let me also thank you for your continued 
leadership and guidance. The progress we have enjoyed to date is due in 
no small measure to your active support of our modernization program 
and what we must do to provide quality service to America's taxpayers 
while meeting our other critical goals and responsibilities. I 
particularly want to thank Chairman Thomas, Chairman Houghton and 
Representatives Coyne, Portman and Cardin for your support in passing 
the President's proposed modifications to the IRS Restructuring and 
Reform Act of 1998 (RRA 98).
    Mr. Chairman, I am pleased to report that we are gradually 
improving our performance across the board. As demonstrated by the 2002 
filing season results, we are seeing further improvements in key areas, 
such as e-filing growth and telephone service. It is important to note 
that our most important judge of the IRS, the American public, has 
begun to respond to our efforts.
    As illustrated in the attached chart, two respected surveys show a 
strong turnaround in IRS public approval. The Roper Starch Surveys 
found our rating increased each of the past three years after an all 
time low in 1998. And the University of Michigan's American Customer 
Satisfaction survey showed greatly improved customer satisfaction among 
individual taxpayers--the largest favorable gain of the 30 Federal 
agencies surveyed.
    Mr. Chairman, the turnaround in the public's rating of the IRS is 
fundamentally important to the health of the tax system. It is not 
acceptable for the government agency that affects more Americans than 
any other to also be the lowest rated. Changing this was a mandate 
incorporated in the RRA 98, and we are beginning, and I stress 
beginning, to deliver on it. While the trend is positive, much more 
remains to be done.
2002 FILING SEASON
    Mr. Chairman, the 2002 tax filing season has been smooth, with 
returns being processed on time, electronic filing increasing 
substantially and improved accessibility and accuracy of telephone 
service. It continues to demonstrate how we can build on positive 
trends in service to taxpayers, especially as our major technology and 
organizational initiatives take effect. We have encountered some 
confusion and a significant number of errors concerning the rate 
reduction credit, but we have been able to keep up with these and get 
taxpayers their refunds on time.
    Projected net collections for FY 2002 will be approximately $2 
trillion. During FY 2002, we also project to receive 231 million 
returns, including over 132 million individual returns, and expect to 
issue over 99 million individual refunds--3 million more than the 
previous year. As of March 23, 2002, the average dollar amount per 
refund is up over 12 percent over last year, and the average refund is 
$1,980.
    Mr. Chairman, so far, we discovered 3.1 million Rate Reduction 
Credit errors. The credit is on line 47 of Form 1040, line 30 of Form 
1040A, and line 7 of Form 1040EZ. The credit is for those taxpayers who 
did not get the maximum benefit through last summer's Advance payments, 
and whose 2001 income or tax amounts qualify them for an additional 
amount.
    We are checking all returns to see that the Rate Reduction Credit 
line is handled properly and will notify taxpayers of any changes we 
make. We are also rejecting e-file returns that show the Advance 
Payment amount on this line, or that show a dependent claiming this 
credit, so that the taxpayer or return preparer may quickly fix the 
problem and transmit a corrected return.
    Although it is not directly related to the filing season, let me 
also note that we corrected a problem for taxpayers trying to obtain an 
Employer Identification Number (EIN) through our new toll-free service. 
This was a start-up glitch that was quickly resolved and we are now 
enjoying an 85 percent level of service (success rate of taxpayers 
seeking assistance for toll-free EIN service).
Electronic Tax Administration
    In 2001, a little more than 40 million taxpayers filed 
electronically--a 13.7 percent rise from last year. Since 1997, e-
filing increased by 110 percent, and on-line filing grew by a 
staggering 1,700 percent. Clearly, the value taxpayers receive from all 
our e-programs is one reason behind the growth. Faster refunds, 
positive acknowledgement of receipt and fewer errors that require time 
consuming letters and telephone calls to correct are key benefits to 
taxpayers.
    One of the important reasons for the IRS' strong showing in the 
ACSI survey was the very high satisfaction rate among electronic 
filers. It was 77.2 points (out of 100)--higher than the previous year 
and the third year in a row that e-file taxpayers expressed increased 
satisfaction.
    The 2002 filing season statistics underscore that an increasing 
number of taxpayers are taking advantage of filing their returns, 
receiving their refunds or paying their taxes electronically. Through 
April 4, 2002, almost 39 million individual taxpayers filed using one 
of the three e-file options; a 14.4 percent increase over the same 
period last year. Let me point out that the number of taxpayers e-
filing from their home computers is up a very impressive 39 percent 
over last year.
    For the fiscal year, we set an aggressive goal of receiving 46 
million returns electronically, a 15 percent increase over last year, 
and I am pleased to say that we are on track to meet or exceed this 
goal.
    The following are some of the key 2002 filing season e-file 
statistics through April 4, 2002 except where noted.

     LNearly 28.6 million taxpayers have e-filed their tax 
returns electronically through an IRS-authorized Electronic Return 
Originator (ERO), a 12.6 percent increase over the same period last 
year.
     LApproximately 7.2 million taxpayers have filed their tax 
returns on-line via their home computer through a third party 
transmitter. OnLine filing is running 40 percent ahead of last year and 
as of April 4, 2002 is already well over the 2001 total volume of 6.8 
million.
     LAlmost 5.3 million taxpayers have chosen to use the 
OnLine Self-Select PINs, up 60.3 percent over last year.
     LOver 3.6 million taxpayers have filed their returns over 
the telephone using the award winning TeleFile system.
     LOverall, as of April 4, over 16 million taxpayers have 
chosen to file both their Federal and State tax returns simultaneously 
in a single electronic transmission, up 23.8 percent from last year's 
13.1 million at this time last year. This year, 37 States and the 
District of Columbia are participating in the program.
New for Individuals for the 2002 Filing Season
    In order to improve our ETA program and ease taxpayer burden, the 
IRS created a series of enhancements for the 2002 filing season and the 
remainder of the fiscal year. These initiatives include:

     LAdding 29 forms and schedules to allow for even greater 
taxpayer participation in the IRS e-file program. This meant we opened 
up e-file eligibility to over 99 percent of all taxpayers, potentially 
adding 38 million new e-filers.
     LContinuing the Self-Select Personal Identification Number 
(PIN) Program that in 2001 enabled approximately nine million taxpayers 
to file paperless returns without having to submit paper signature 
jurats. The Self-Select PIN is a five-digit PIN that taxpayers can 
create to sign their returns electronically.
     LContinuing the Extension of Time to File by Phone. Anyone 
who filed a tax return last year can request over the telephone an 
automatic extension of time (to August 15, 2002) to file his or her tax 
returns. Form 4868, Application for Automatic Extension of Time to File 
U.S. Individual Income Tax return, has details on required information 
and explains how to pay a balance by telephone.
     LContinuing the Debt Indicator Program and providing the 
Debt Indicator on every acknowledgment report. This information will be 
provided for every electronically-filed return for customer service 
purposes or for approval of financial products.
     LExpanding the electronic payment options available to 
taxpayers by accepting credit cards for payment of installment 
agreements and delinquent taxes. As of April 4, approximately 46,449 
payments averaging $2,459 were made via credit card and another 84,671 
payments averaging $979 were made by Automated Clearing House (ACH) 
Direct Debit where taxpayers can authorize either their checking or 
savings account to be debited.
     LAdding Maryland, Oregon and West Virginia to the FedState 
TeleFile program that already includes Indiana, Kentucky, Oklahoma and 
Georgia.
     LReleasing the initial series of Web-based services for 
practitioners including registration and application capabilities, 
requesting and receiving taxpayer transcripts on-line, submitting 
disclosure authorization requests electronically, verifying Taxpayer 
Identification Numbers, and getting personal assistance to resolve 
taxpayer problems.
ETA Also Easing Business Taxpayer Burden
    A strong ETA program may be even more important for reducing burden 
for businesses than for individual taxpayers. In addition to their 
annual income tax returns, businesses also have to file various 
employment tax returns and information returns. Businesses also make a 
lot of payments to the Federal Government, such as withholding and 
unemployment taxes. In fact, payments are a business' most frequent 
transaction with the IRS.
    These requirements add up to a lot of transactions between 
businesses and the IRS--23 million employers' quarterly tax returns; 
5.5 million employers annual unemployment tax returns; 5.5 million 
corporate tax returns and 2 million partnership returns, including the 
processing of over 11 million K-1s. That is an enormous amount of paper 
and it does not include the millions of checks that accompany them.
    We want to eliminate this blizzard of paper and convert all of 
these transactions to fast, accurate, paper free electronic methods. In 
2002, the IRS continues to make progress serving the electronic tax 
administration needs of this important sector.
    Mr. Chairman, to promote business e-filing, we have placed 
advertisements in publications, including Fortune Magazine. Businesses 
can now file electronically both their 940 and 941 employment tax 
returns. Some businesses may even qualify to file using a telephone. We 
have also opened the door for a number of other key forms to be filed 
electronically, such as Form 1099 to report other income. We are 
particularly pleased that we can now offer electronic filing of Form 
1065, to report partnership income, and the K-1s that accompany them. 
We are also hard at work designing Form 1120, Corporate Tax Return e-
file program. Implementation is slated for a year from now.
    I mentioned that payments from businesses, especially payroll 
deposits and quarterly returns are the most common transactions 
businesses have with the IRS. The Electronic Federal Tax Payment System 
(EFTPS) is an enormous success story in this regard. Through EFTPS, 
both businesses and individuals can make Federal tax payments 
electronically. Since its inception in November 1996, businesses have 
used it to pay more than $5.7 trillion in Federal taxes.
    On September 6, 2001, we successfully launched IRS' first on-line 
payment system--EFTPS-OnLine. It provides a convenient and secure 
method for paying all Federal taxes through a secure Web site. Let me 
stress that confidentiality and privacy of taxpayer information are our 
highest priorities. EFTPS-OnLine users can feel confident that their 
private information will be protected.
Spurring Further e-file Growth
    Mr. Chairman, in its December 21, 2001 report to you, ``Assessment 
of IRS' Tax Filing Season,'' the GAO observed that in spite of the 
growth in electronic filing and our efforts to identify and eliminate 
impediments, the 13.7 percent growth in 2001 was still below our goal 
of 20 percent. Of particular concern to both the GAO and IRS is why 
approximately 40 million individual income tax returns were prepared on 
computer but filed on paper in 2001. The IRS and the Administration are 
taking and proposing actions to address the problem.
    This year, we focused our e-file marketing campaign on taxpayers 
who prepare their returns by computer but file on paper, and taxpayers 
who use the services of tax professionals but file on paper. We also 
agree with GAO on the need to further survey these filers to determine 
why they did not file electronically and how we can overcome these 
barriers.
    In addition, the President proposed in his FY 2003 budget that the 
due date for returns filed and paid electronically be extended. During 
the March 20th mark up of the ``Taxpayer Protection and IRS 
Accountability Act of 2002,'' the House Ways and Means Committee 
included a provision that will extend next year's filing date for 
electronic returns to April 30.
    The Administration also proposes in its budget submission ``an 
easy, no-cost option for taxpayers to file their tax return online.'' 
Unfortunately, there has been some confusion regarding this proposal. 
The Administration's proposal to give taxpayers the option to file 
their tax returns on-line without charge is based on two principles: no 
one should be forced to pay extra just to file his or her tax return, 
and the IRS should not get into the software business.
    In a statement issued on January 30, 2002, Treasury Secretary 
O'Neill stated, ``I don't intend for the IRS to get into the software 
business, but rather to open a constructive dialogue with those who 
already have established expertise in this field. In the end, this 
effort should come up with a better way to save time and money for both 
taxpayers and the government.'' The IRS totally concurs with the 
cooperative approach enunciated by the Secretary and we will follow it 
to the letter.
Web-Based Help
    The IRS Web site at www.irs.gov continues to be extremely popular 
with taxpayers. As of March 14, the IRS Web site was listed as Number 3 
in the Lycos Top 50 searches. In 2001, it posted 2.7 billion hits with 
more than 336 million forms and publications downloaded. For fiscal 
year 2002 through March 31, there were 1.95 billion Web site hits, up 
36 percent over the same period last year.
    I should note that in January, the IRS introduced a newly designed 
Web site, aimed at making it easier for taxpayers to find the 
information they want on the Web. Following our overall strategy of 
making the IRS customer-focused, the home page immediately provides 
taxpayers a way to find information based simply on whether you are an 
individual or business taxpayer.
    The Small Business/Self-Employed Community section on our Web site 
is an excellent example. It is dedicated to the needs of this important 
taxpayer group who often confront more complex tax issues than those 
who have their taxes withheld by an employer.
    Our ultimate goal is to transform our Web site from an information-
only portal to a world-class transaction based gateway. However, some 
things have not changed. Anyone with Internet access can receive: tax 
forms, instructions, and publications; the latest tax information and 
tax law changes; tax tables and rate schedules; and hypertext versions 
of all taxpayer information publications, including the very popular 
Publication 17, ``Your Federal Income Tax''; all TeleTax topics; 
answers to the most frequently asked tax questions; a library of tax 
regulations; and the weekly Internal Revenue Bulletin that contains all 
the latest revenue rulings, revenue procedures, notices, announcements, 
proposed regulations and final regulations.
    Mr. Chairman, let me point to another benefit of our Web site. It 
is an excellent tool for alerting taxpayers and the media to various 
fraudulent schemes, including the slavery reparations scam, being 
perpetrated upon them by unscrupulous promoters. There is a quick link 
from our portal page to IRS Criminal Investigation ``Tax Frauds Alert'' 
page that provides in one place a comprehensive overview of the 
different schemes and what we are doing to combat them. It also lists 
the number (1-800-829-0433) for taxpayers to report suspected tax fraud 
activity.
                          Telephone Assistance
    To improve customer service, and based on an AT&T usage study, the 
IRS aligned its toll-free service hours last year to meet customer 
demand. Beginning October 7, 2001, IRS assistors are available 7 a.m. 
to 10 p.m. Monday through Friday local time. During the filing season 
(January 2 through April 15, 2002), assistor services are available on 
Saturdays from 9 a.m. to 5 p.m. Assistor services are also available on 
President's Day and Sunday April 7 and April 14, 2002. IRS automated 
assistance systems continue to be available 24 hours a day, 7 days a 
week.
    Primarily because of increased calls concerning refunds and the 
rate reduction credit, the total volume of incoming calls on our toll-
free lines for the fiscal year through March 30 has been up 13 percent 
over last year, totaling 51.1 million calls for the first half of the 
fiscal year.
    Despite this substantial increase in the volume of calls, for the 
first half of the year through March 30, 2002 approximately 66 percent 
of taxpayers who wanted to talk to a customer service representative 
got through, compared to 68 percent last year. In the last four weeks, 
service improved further, with 74 percent of taxpayers getting through 
to customer service representatives. We have set a goal for the whole 
year of 71 percent.
    Of great interest to taxpayers, the average wait time for questions 
on tax law was 2.58 minutes--down from 4.27 minutes last year. Wait 
time for calls on account questions was 4.76 minutes compared to 6.11 
minutes last year.
    In addition, 45.3 million taxpayers used our automated services to 
get information, including refund status, an increase of 8 percent 
since last year, and the upward trend continues.
    Once connected, taxpayers must get prompt, accurate and courteous 
answers to their account and tax questions. Here too we have made 
substantial progress towards providing better service to taxpayers. The 
telephone correct response rates for tax law and tax account questions 
showed a marked improvement in FY 2002. They were up to 83 percent and 
89 percent respectively as compared to 75 percent and 88 percent over 
the same period last year.
    Let me note too, that by September 24, 2001, we established a 
special telephone line for victims of the terrorist attacks and since 
then, we have provided over 90 percent level of service on this line.
    Mr. Chairman, to increase productivity and quality of service, we 
must give our employees the technology and tools they need to do their 
jobs at a high level. In this regard, our Business Systems 
Modernization (BSM) program is delivering both short- and long-term 
improvements.
    The first of the BSM projects, Customer Communications 2001, was 
deployed in July 2001, which allows us to route calls more precisely to 
assistors with the necessary expertise. We must also give our assistors 
specialized knowledge so they can better answer taxpayer questions 
about a very complex, difficult and changing Tax Code. Our new 
technology will allow us to route calls more precisely to assistors 
with the necessary expertise.
Practitioner Priority Service
    This new nationwide toll-free, accounts-related service for all tax 
practitioners is being rolled out in three phases at 45-day intervals; 
the first was launched on January 2, 2002. This service, which will 
replace the former Practitioner Hotline, will be the practitioners' 
first point of contact for assistance regarding taxpayers' account-
related issues.
    Calls will be routed to one of five IRS campus sites (Brookhaven, 
NY; Cincinnati, OH; Memphis, TN; Ogden, UT; and Philadelphia, PA) based 
on the practitioner's area code. All sites will handle both individual 
and business inquiries, and any issues outside the scope of the 
employees' authority will be priority routed to other IRS functions.
    Expected benefits for practitioners include improvements in overall 
consistency and quality of service; improved accessibility into the 
system and reduced wait times; and dealing with the employees who are 
specially trained to handle practitioner issues.
Forms By Fax and Phone
    Taxpayers can receive more than 100 frequently used tax forms 7 
days a week, 24-hours-a-day from IRS TaxFax. Taxpayers can request up 
to three items per call. Taxpayers use their fax machine to dial the 
service at 703-368-9694. The only cost to the taxpayer is the cost of 
the call. Taxpayers can also request forms and publications by calling 
1-800-TAX-FORM.
Recorded Tax Information
    TeleTax has 150 topics available 24 hours a day using a Touch-tone 
phone. Taxpayers can call (toll-free) 1-800-829-4477 to hear recorded 
information on tax subjects such as earned income credit, child care/
elderly credit, and dependents or other topics, such as electronic 
filing, which form to use, or what to do if you cannot pay your taxes. 
As of March 30, 2002, over 1.9 million have taken advantage of the 
recorded tax information features of TeleTax this fiscal year.
Automated Refund Information
    In FY 2001, more than 54 million taxpayers used the Automated 
Refund Information system on TeleTax to check on the issuance of their 
refund checks. As of March 30, 2002, the number stands at over 35.8 
million--up .5 million from this time last year. Taxpayers may call 1-
800-829-4477 to check on their refund 24 hours a day, 7 days a week.
                        Filing Burden Reduction
    In addition to our many popular electronic programs, such as e-
file, the IRS is also making other efforts to reduce the time and 
effort it takes taxpayers to file and pay their taxes. For example, 
Schedule D, the form that millions of taxpayers use to calculate their 
capital gains and losses, was redesigned for the 2002 tax-filing 
season. The goal of the revision, which cuts 14 lines from the 
schedule, is to reduce the difficulty that individuals face when 
filling out their return. As noted in our press release announcing the 
change, ``Calculating capital gains and losses should not be a capital 
pain.''
    This year's tax form for individuals also contains a small change 
that we hope will make a big difference to the millions of Americans 
who make minor errors filling out their returns. Taxpayers who fill out 
a new Form 1040 box selecting a third party designee will enable that 
person--be it friend, family member or paid preparer--to talk directly 
with the IRS to correct questions during the processing of the return.
    Such errors include simple math errors and data omissions, such as 
an incorrect Social Security Number. The designation also enables the 
third party to discuss the status of a refund, payment or other notice 
with IRS representatives.
    This new option balances the taxpayer's need for privacy with the 
reality that for millions of people a friend, family member or tax 
professional plays a key role in the preparation of their return. The 
taxpayer retains privacy but has the ability to make it easier to 
resolve routine problems. The bottom line is this improves customer 
service and reduces headaches for taxpayers, practitioners and the IRS.
    The new third party designation, located just above the signature 
line of Form 1040, expands on the success of the paid-preparer checkbox 
on last year's Form 1040 by enabling the taxpayer to designate a friend 
or a family member as well. More than 37 million taxpayers marked the 
checkbox option during last year's tax season. However, the third party 
designation does not eliminate the need for a Power of Attorney for 
issues dealing with examinations, under reported income, appeals and 
collection notices.
                                CD-ROMs
    The IRS has also developed a number of innovative products for 
small business taxpayers. The Small Business Resource Guide 2002 on CD-
ROM is a must for every small-business owner, or any taxpayer about to 
start a business. This handy, interactive CD contains all the business 
tax forms, instructions and publications to manage a business 
successfully. It also includes valuable information concerning the IRS 
Disaster Relief Efforts and the Welfare-to-Work Credit. Up to five free 
copies can be ordered on-line from the IRS.
    The IRS has developed two new CD-ROMs to help educate small 
business owners on their tax responsibilities. The first, Introduction 
to Federal Taxes for Small Business/Self-Employed, introduces business 
students, new small business owners, and self-employed entrepreneurs to 
IRS tax law in an easy to understand format.
    The second CD-ROM is A Virtual Small Business Workshop. This 
powerful tool replicates the best of the IRS' years of presentations of 
workshops for small businesses. It provides information on all the key 
aspects of the tax implications involved in establishing and running a 
small business. The user sees the instructor along with an outline of 
the presentation. In addition, the closed caption option provides the 
instruction in English, Spanish, and Mandarin Chinese.
    These two CD-ROMs are also free and can be ordered by calling 1-
800-829-3676 (no on-line ordering at this time).
Taxpayer Assistance Centers
    For those taxpayers who prefer to visit an IRS office, walk-in 
service is available at more than 400 locations nationwide. At many 
sites, walk-in service will be offered on 12 Saturdays between January 
27 and April 14. As of March 16, 2002, we have served over 3.3 million 
taxpayers at all Taxpayer Assistance Centers--slightly more than at 
this time last year.
    The Saturday Service sites were selected based on their weekend 
accessibility, year-round operational status, and high traffic volume. 
They include non-traditional locations, such as shopping malls, 
community centers and post offices.
    Mr. Chairman, in the past, the IRS did not place as high priority 
as it should have on what were called, ``walk-in'' sites. The services 
offered at them was limited and often of poor quality. However, through 
our new Field Assistance Concept of Operations, we will better serve 
taxpayers at our taxpayer assistance centers. We will help them meet 
their filing and paying responsibilities including answering their tax 
law questions and providing forms and limited courtesy return 
preparation.
    Taxpayers with incomes of $33,000 or less can receive help filing 
their individual income tax returns. This courtesy return preparation 
ensures assistance for all taxpayers qualifying for the Earned Income 
Tax Credit, without placing the government in competition with private 
industry. Taxpayers whose income or preparation needs exceed the basic 
service will receive service options, such as referrals.
    Free tax preparation is available through the Volunteer Income Tax 
Assistance (VITA) and Tax Counseling for the Elderly (TCE) programs in 
most communities. Volunteers help prepare basic tax returns for low-
income taxpayers, persons with disabilities, the elderly, and non-
English speaking people. Taxpayers can call 1-800-829-1040 to find 
their nearest VITA or TCE site. They may also call AARP--the largest 
TCE participant--at 1-877-227-7844 to see if there is a Tax Aide site 
in their community.
    Throughout the year, and at a variety of locations, we also 
schedule the highly acclaimed Problem Solving Days--the last was held 
on November 3, 2001 at 46 Taxpayer Assistance Centers--to resolve long-
standing taxpayer issues for those who cannot take advantage of weekday 
problem solving services.
    Problem Solving Days have an excellent track record. But we must 
bring what we learn from them to our daily operations. Every day should 
be problem solving day at the IRS, not just three or four times a year. 
That means using a cross-functional approach to resolve most tax 
account issues with a single visit or phone call at any time throughout 
the year.
    To help us meet this need, we created a new job at the IRS, ``Tax 
Resolution Representative.'' These IRS employees will receive the 
training and authority to provide ``one-stop-service'' for a broad 
range of issues ranging from answering tax questions to resolving 
payment problems.
    Mr. Chairman, I want to make one more important point about out 
Taxpayer Assistance Centers. In its assessment of the 2001 filing 
season, the GAO noted that the IRS did not previously measure TAC 
quality; the 2002 filing season is the first year we will measure it. 
Indeed, this process is just beginning, much as it was for telephone 
service several years ago.
    The Treasury Inspector General for Tax Administration (TIGTA) was 
also asked by Congress to perform accuracy reviews. It is our sincere 
desire to work closely with TIGTA to analyze their data to help us meet 
the challenges we confront at our Taxpayer Assistance Centers.
                Tax Materials and Assistance in Spanish
    Spanish-speaking taxpayers can receive information through recorded 
tax topics, free tax publications, toll-free telephone assistance, our 
Web site, and at Taxpayer Assistance Centers.
    TeleTax provides the same helpful 151 tax topics and refund 
information in Spanish and is available 24 hours a day, 7 days a week 
at 1-800-829-4477. Free Spanish publications are also available by 
calling 1-800-TAX-FORM (1-800-829-3676). Some of the more popular ones 
are:

  Publication 1SP, ``Derechos del Contribuyente (Your Rights as a 
        Taxpayer).''
  Publication 579SP, ``Como Preparar la Declaracion de Impuesto,'' 
        explains who has to file a Federal tax return and other 
        important topics, such as which form to file, who are 
        dependents, what income is taxable and nontaxable, and what 
        some of the more common tax credits are.
  Publication 596SP, ``Credito por Ingreso del Trabajo,'' provides 
        details on the Earned Income Tax Credit.

    Taxpayers can also talk with a Spanish-speaking IRS representative 
by calling toll free 1-800-829-1040 between the hours of 7:00 a.m. and 
10:00 p.m. on weekdays and 9:00 a.m. and 5:00 p.m. on Saturdays through 
April 13. This year we provided our Customer Service Representatives 
with both Spanish Language supplemental training and a new Spanish 
language Probe and Response Guide and glossary of Spanish language 
technical terms. Spanish-speaking taxpayers can also go to a new 
special Spanish section on our Web site. Spanish and English services 
are available too at all IRS kiosks, as well as Russian, Korean and 
Chinese at our Flushing, NY kiosk in the Queens Public Library.
    In addition, we offer Spanish language services in every one of our 
approximately 416 Taxpayer Assistance Centers nationwide. Many are 
located in areas with high-density Spanish-speaking populations and 
include employees recruited from these same communities. We offer this 
in-person service as a matter of routine.
    In these and at all other offices, we also have contract telephone 
interpreter services available to help us to provide service to any 
customers who do not speak English. These interpreter services include 
Spanish as well as almost every other common language in the world.
MODIFICATIONS TO THE IRS RESTRUCTURING
AND REFORM ACT OF 1998 (RRA 98)
    Mr. Chairman, in the FY 2003 budget submission, the Administration 
proposed modifications to RRA 98. On March 20, 2002, the House Ways and 
Means Committee reported out the ``Taxpayer Protection and IRS 
Accountability Act of 2002'' that contains five of these proposals. We 
commend the Committee for its actions and believe that these 
modifications preserve the intent of the Act while allowing us to 
administer it more efficiently and effectively.
    There are six parts to the Administration's proposed modifications. 
The first modifies infractions subject to Section 1203 of RRA 98 and 
permits a broader range of available penalties. Our ability to 
efficiently administer the tax code is currently hampered by a strong 
fear among our employees that they will be subject to unfounded 1203 
allegations, and perhaps lose their jobs as a result. This proposal 
will reduce employee anxiety resulting from unduly harsh discipline or 
unfounded allegations.
    The second part adopts measures to curb the large number of 
frivolous submissions and filings that are intended to impede or delay 
tax administration. The third allows IRS to terminate installment 
agreements when taxpayers fail to make timely tax deposits and file tax 
returns on current liabilities. (This provision was not contained in 
the Committee-reported bill.) The fourth part streamlines jurisdiction 
over collection due process cases in the Tax Court, thereby reducing 
the cycle time for certain collection due process cases.
    The fifth part permits taxpayers to enter installment agreements 
that do not guarantee full payment of liability over the life of the 
agreement. It allows the IRS to enter agreements with taxpayers who 
desire to resolve their tax obligations but cannot make payments large 
enough to satisfy their entire liability and for whom an offer in 
compromise is not a viable alternative. The sixth and last provision 
would eliminate the monetary threshold for IRS Chief Counsel reviews of 
offers in compromise.
NATIONAL RESEARCH PROGRAM
    Earlier this year, the IRS proposed to reestablish a key component 
of its ongoing compliance effort to help ensure fairness for America's 
taxpayers. The National Research Program (NRP) is designed to 
accurately measure tax compliance while minimizing the need to contact 
taxpayers during the process.
    The NRP is developing innovative approaches to measure taxpayer 
compliance with the tax law. It will: (1) be far less intrusive and 
burdensome on taxpayers than previous compliance studies; (2) help the 
IRS build better compliance programs to more effectively catch tax 
cheating and help ensure all taxpayers pay a fair share; and (3) help 
reduce audits of taxpayers who filed an accurate return by at least 
15,000 tax returns a year.
    As part of ongoing compliance operations, NRP will focus on 
measuring three key areas of tax administration--filing compliance, 
payment compliance and reporting compliance. A key element involves 
measuring the accuracy of reporting information on tax returns. The IRS 
has overhauled the reporting component to minimize disruptions to 
taxpayers during the study.
    Ultimately, this project will help all taxpayers by giving the 
agency timely, accurate information about tax compliance. This 
information will allow the IRS to replace outdated audit selection 
formulas and develop compliance efforts directed toward the tax returns 
most likely to have errors, rather than those from honest taxpayers.
    In late fall of this year, the NRP will begin reviewing a small, 
statistically valid sample of individual returns from the 1040 family. 
The IRS will work closely with tax practitioners, Members of Congress 
and other key stakeholders to finalize the project.
FY 2003 RESOURCE REQUEST
    Mr. Chairman, the IRS budget request for FY 2003 is $10.418 billion 
and full-time equivalent employment (FTE) of 101,080. The request is 
$482 million more than last year's $9.936 billion appropriation. The 
largest programmatic component of this increase is $259 million to 
enhance customer service and compliance, of which $196 million will be 
funded through a redeployment of resources within our base budget.
    Overall as shown in the attached chart, the IRS is proposing to 
achieve $259 million in increased program resources and program 
delivery at a net requested increase of only $63 million. Therefore, 76 
percent of the improvement is being achieved by improved internal 
efficiency and redeployments.
    The funding increase request also maintains momentum in the IRS 
Business Systems Modernization projects with $58 million. The budget 
increase for FY 2003 will allow us to fund these critical projects as 
they move from the planning and design phase to development and 
implementation. The remaining increase would fund pay raises, and 
inflation, $10 million for Tier B Projects and adjustments for Homeland 
Security funds appropriated in FY 2002.
    In addition, $39 million of the total increase is requested as part 
of a legislative proposal to change the accounting of pension and 
retiree benefits costs. Please note that although the increase of $39 
million is the incremental change from the FY 2002 appropriation (as 
adjusted), the actual increase to our FY 2002 base for this proposal 
will be $503 million. These costs are transfers of funds that were 
previously included in other agency budgets and do not represent any 
net increases in IRS programs.
    To help create a ``World Class Treasury Department,'' Secretary 
O'Neill challenged each bureau to review all programs on a continual 
basis and redirect resources to meet needs, rather than asking for 
funding increases. Budget and performance integration, as part of the 
President's Management Agenda, requires this kind of business review, 
with an emphasis on best results at the lowest total cost.
    Indeed, let me stress the process that underlies the FY 2003 
request. For the first time, we fully integrated the development of our 
budget with the establishment of performance measures. First, we 
determined the highest priority resources needed to increase customer 
service and compliance. In addition, as part of the budget process, 
IRS' senior team conducted a review and prioritization of agency-wide 
needs for FY 2003 and searched for the most efficient allocation of 
resources. The realignment of resources woven throughout the FY 2003 
budget comes through reengineering, efficiencies and investment in 
modernized systems. To this end, the review developed 2,287 FTE that 
could be re-deployed to high priority areas in customer service and 
compliance.
OPERATIONS

                    Highest Priority Resource Needs

Customer Service and Workload Increases (+1,595 FTE, $91M)
    In FY 2003, the IRS must build on the gains it has made in customer 
service if we are to achieve our first strategic goal, ``top quality 
service to each taxpayer in every interaction.'' We are still not 
providing a consistent high level of service that taxpayers expect and 
deserve. We must continue to improve taxpayer access to our toll-free 
telephone lines and the accuracy of the responses we give to tax law 
and account questions. We must continue to improve the service at our 
taxpayer assistance centers. We must further reduce taxpayer burden. We 
must continue to increase e-file options. We must better administer the 
RRA 98 taxpayer rights provisions. And we must give our employees the 
training and tools to meet these needs. The highlights of some of the 
following initiatives will help us meet our goals.

     LIncreased Offer in Compromise (OIC) Cases. This 
initiative is designed to address the escalating OIC inventory by 
centralizing and streamlining the processing. Cases sent to the field 
will include all background financial data needed to conduct the 
investigation, thereby reducing the amount of time that revenue 
officers must spend on gathering this information.
     LTelephone Level of Service. Taxpayers must still speak to 
live assistors to answer tax law and account questions as well as 
Automated Collection System (ACS) inquiries. Additional FTE are 
necessary to address current demand and to meet taxpayers' legitimate 
expectations that they receive service comparable to what is offered by 
the best private sector companies.
     LMulti-Lingual ACS. The Multi-Lingual Automated Collection 
Service (ACS) will help meet taxpayer growing demands for timely, 
accurate and efficient services in languages other than English.
     LImproving Correspondence. We are improving the clarity of 
our communications with taxpayers through a redesign of 24 of our 
notices over the next two years.
     LFiling Services. We must continue to provide filing 
services--from e-filing to submission processing to timeliness of 
refunds--and handle a projected increase in the number of returns 
filed.
Enhanced Compliance Strategies (+1,857 FTE, $125M)
    In 2001, we began to stabilize the long-term decline in compliance 
activities while beginning to focus effectively and efficiently on the 
four key areas of non-compliance and maintaining adequate coverage of 
other areas. However, we still must address a number of challenges. For 
example, from 1993 to 2001, the number of returns reporting adjusted 
gross income in excess of $100,000 grew by 163 percent. We must keep 
pace with this increase by expanding the number of these returns that 
are examined in IRS field and office programs. We must also tackle the 
$66 billion in our total potentially collectable inventory. And we must 
focus on the proliferation of tax scams ranging from sophisticated 
illegal offshore trust programs to the slavery reparations scheme being 
perpetrated upon African-Americans. The following are the highlights of 
our enhanced compliance strategies for FY 2003. A detailed description 
can be found in our congressional justification.

     LStabilize Audit Rates. The IRS will devote resources to 
stop the overall declining audit rates and will dedicate more resources 
to auditing partnerships and other passthrough entities.
     LAbusive Trusts. Experts estimate that the revenue loss to 
our nation due to abusive trusts could run into the tens of billions of 
dollars. We now have a coordinated strategy to deal with this growing 
problem using a full range of tools from public education to civil and 
criminal enforcement against both promoters and participants.
     LHigh-Income Returns. From 1993 to 2001, the number of 
returns over $100,000 and $1 million dollars grew by 163 and 259 
percent respectively. However, IRS examination of these returns has not 
kept pace and we must now narrow the gap.
     LHighest Priority Collection. To address the mounting 
employment and income tax gaps, the IRS will dedicate more resources to 
high priority compliance and collection cases involving unpaid 
employment taxes.
     LFraud Referral. Referrals and leads generated from the 
Lead Development Centers and the Fraud Detection Centers will produce 
more quality criminal investigations cases and help ensure public 
confidence in the fairness of our of tax administration system.
     LAutomated Underreporter. To improve voluntary reporting 
on individual income tax returns, the Remote Automated Underreporter 
Program will utilize a national rotational inventory approach for case 
selection.
     LEmployment Tax. To combat non-compliance with employment 
tax laws, the IRS will boost resources for legal source tax crime cases 
with a special emphasis on emerging problems, such as the use of 
temporary employment agencies/employee leasing agencies to evade 
employment and income taxes.
     LMoney Laundering. IRS Criminal Investigation (CI) was 
delegated primary investigative jurisdiction in all money laundering 
investigations where the underlying conduct is a violation of the 
income tax laws.
     Le-Crimes. CI must continue to develop investigative 
knowledge and techniques to keep pace with the growing number of e-
crimes, such as fraud and theft.
     LCriminal Tax Cases. Continued development of a close 
relationship between Chief Counsel Criminal Tax and CI will help to 
ensure that legal errors in the investigative process are minimized and 
the chances for successful prosecution are maximized.
Contract Services (+$44M)
    The IRS must also pay for a number of non-labor program increases, 
many of which are mandated by Executive Order or departmental 
regulations. For example, in response to concerns raised by GAO and 
TIGTA, we must provide for enhanced guard services at our submission 
processing and computer centers. In addition, we are requesting funding 
for physical security upgrades such as more secure gates and entrances, 
and barriers that can be raised and lowered. Other items include the 
Public Transportation Subsidy, which was increased from $65 to $100/
month.
                RESOURCES RE-DEPLOYED THROUGH INCREASED
                      EFFICIENCY AND PRODUCTIVITY
    A combination of strategic redeployment of staff and labor saving 
programs will allow the IRS to improve its level of taxpayer service 
without commensurate increases in the number of FTE applied. Targeted 
improvement projects, such as Reengineering/Quality efforts and labor 
savings from e-file and e-Services can be reapplied to other high 
priority programs. Technology modernization programs will generate the 
bulk of the FTE savings.
Improvement Projects (Redeployment of 1,779 FTE, $107M)
    The IRS identified FTE redeployments from improvement projects that 
are expected to come to fruition in FY 2003 and are highlighted below. 
The FTE will be reinvested to fund the top priority needs identified 
below:

     LReengineering/Quality Improvements. Reengineering and 
Quality Improvement projects and programs will focus on redesigning 
internal processes, policies, and procedures. Updating the antiquated 
workload selection system will, for example, reduce/eliminate the 
substantial number of returns that are ordered, classified, and never 
worked.
     Le-file. In addition to the many taxpayer benefits, e-file 
also provides clear cost savings and burden reductions for the IRS, 
enabling us to redirect precious resources from processing to customer 
service and compliance programs. In addition to expanding electronic 
filing for individual taxpayers, the IRS will promote the electronic 
filing of all business tax returns in FY 2003. Our ultimate goal is to 
convert all business transactions with the IRS to fast, accurate, 
paper-free electronic methods. Through e-Services, we will also provide 
to tax practitioners easy-to-use electronic products and services.
     LCustomer Relationship Management. The funding for this 
project will pay for training travel, operating travel and support 
costs related to bringing IRS staff quickly up to speed on the newly 
improved Corporate Tax Analysis software. The software's main strengths 
are its capacity to do carryback/carryover calculations for net 
operating losses (and other losses), the interaction of losses and 
charitable contributions, alternative minimum tax calculations and the 
foreign tax credit calculations--including carrybacks and 
carryforwards.
     LInformation Technology Projects. Two projects are 
expected to begin realizing savings in FY 2003: the Employee Plan 
Determination System Redesign (EDSR) and the Remittance Transaction 
Register (RTR). EDSR is expected to reduce cycle time and improve 
quality of determination letters. RTR is projected to improve 
efficiency in submission processing by providing all Lockbox payment 
information online soon after receipt, reducing from one month to just 
three days response time for reconciling payment information and 
responding to payment information queries.
Workload Decreases (Redeployment of 508 FTE, $50.5M)
     LReduced Field Innocent Spouse. The initial high inventory 
of Innocent Spouse cases is expected to decline to a point where they 
can be processed without significant delays on our part. Revenue Agents 
and Tax Auditor FTEs assigned to this program will be re-deployed to 
address compliance in other areas.
     LReduced Filing Season Support. We will reduce the FTEs in 
the Small Business and Self-Employed operating division planned for 
customer service details.
     LNarcotics Program. With redeployments realized from the 
narcotics program realignment, 67 FTE will be used in the Fraud 
Referral Program and 18 FTE will be used in the Money Laundering 
Strategy Program.
     LReduced Tax Court Cases. The number of cases filed in the 
Tax Court is declining. Emphasis on pre-filing resolution of cases 
through programs such as Advance Pricing Agreements is also expected to 
moderate increases in Tax Court litigation in the future, as well as 
Refund and Appellate litigation.
Targeted Efficiency Improvements (Redeployment of $39M)
    Redeployment is expected from the Treasury's approach to better 
business practices to remove or reduce current efforts that do not have 
significant programmatic value. This is targeted to produce $39 million 
in redeployments.
                      MAINTAIN CURRENT OPERATIONS
    The IRS is still a labor-intensive organization and a stable 
workforce is critical to carrying out our mission. We must maintain 
current operations, protect the integrity of the tax filing season, 
oversee tax administration programs and continue to implement 
organizational modernization. To do so, the IRS must have the resources 
to pay for the inflationary costs associated with statutory pay and 
other mandatory increases described below.

     LMaintaining Current Services Level (+$295M). Needed to 
maintain FY 2002 program levels in FY 2003 by funding pay, benefits, 
and non-labor inflationary costs.
     LWithin-Grade Increases (+$37M). To cover the costs of 
within-grade pay increases for on-board employees.
     LHomeland Security (+$10M). For the enhanced security 
arrangements required by the Homeland Security supplemental. These 
funds were appropriated as a consequence of the September 11, 2001 
terrorist attacks and other related security concerns.
     LHomeland Security Non-Recur (-$31M). Funding in the 
amount of $31 million from the FY 2002 will be non-recurred in the FY 
2003 budget.
                  EARNED INCOME TAX CREDIT INITIATIVES
    In FY 2003, funding requirements for the Earned Income Tax Credit 
(EITC) Compliance Initiative Appropriation are projected to be 
$154,346,000, an increase of $406,000 over the FY 2002 funding level of 
$153,940,000. The FTE level of 2,353 is unchanged from FY 2002.
    This appropriation provides for customer service and public 
outreach programs, enforcement activities and research efforts to 
reduce overclaims and erroneous filings associated with the EITC.
                   BUSINESS SYSTEMS MODERNIZATION AND
                 OTHER INFORMATION TECHNOLOGY PROJECTS
    The IRS' antiquated computer systems do not efficiently or 
effectively serve America's taxpayers, nor meet today's business needs. 
They are one of the fundamental obstacles to providing consistent top-
quality service. Failing to modernize IRS' tax administration business 
systems would require a significant increase in resources to maintain 
the old legacy systems while not addressing their underlying 
deficiencies that will only worsen with time.
    Business Systems Modernization will update our antiquated 
technology and change the entire way the IRS interacts and conducts 
business with taxpayers and stakeholders. Indeed, we do not view 
systems modernization as a separate entity, but rather as one of the 
major ways we can achieve all of RRA 98's goals within realistic budget 
resources.
    Over the past two years, BSM graduated from strategic planning and 
systems design to business results. As shown in the attached chart--the 
green blocks in FY 2001 and FY 2002--the IRS will put in place three 
critical building blocks. In 2001, we established a communications 
infrastructure to manage the enormous volume of taxpayer phone calls. 
In 2002, we will move the records of some taxpayers out of the 1960's 
tape-based system to a modern, reliable database. And we will establish 
an IRS-wide security system providing internal and external secure 
access and communications to our systems.
    These three deliveries are some of the most essential and difficult 
building blocks of the modernization program. Their lack severely 
impeded our ability to modernize our systems and imposed enormous risks 
and costs on the entire tax administration system. As BSM progresses, 
these programs will continue to be enhanced and deployed on an ever-
increasing scale until they eventually support the entire tax system.
    Valuable lessons were learned as we developed and implemented these 
projects, and we are giving equal attention to improving the quality 
and rigor of our management processes. Completing the first two 
versions of the Enterprise Architecture, as shown in the chart, was a 
major step. Based on my 28 years experience in the IT business, I 
believe that this Enterprise Architecture is the most complete and 
useful of such architecture in industry or government.
    We are also utilizing the rigorous management processes of the 
Enterprise Life Cycle, while at the same time ensuring that all BSM 
projects adhere to the Enterprise Architecture. In addition, we are 
addressing remaining management weaknesses, including those identified 
by GAO and we are striving to achieve a standard know as the Software 
Acquisition Capability Maturity Model Level 2--a recognized standard 
that has not been achieved in any Federal Agency with the exception of 
DoD's Abrams Tank Division.
    I want to stress, Mr. Chairman, that we will continue to use a 
formal methodology to prioritize, approve, fund and evaluate our 
portfolio of BSM investments. This methodology enforces a documented, 
repeatable and measurable process for managing investments throughout 
their life cycle. Investment decisions are approved by the IRS Core 
Business System Executive Steering Committee, chaired by the 
Commissioner.
                          FY 2003 BSM Request
    The proposed $450 million FY 2003 BSM budget request includes an 
increase of $58.4 million over last year's appropriation. Let me 
summarize the key BSM projects that are addressed in the funding 
request. A complete description of each can be found in our 
congressional justification.
Customer Account Data Engine (CADE)
    CADE is the foundation for all of IRS' tax administration systems. 
It will replace the tape-based Master Files that currently contain the 
only authoritative information on all individual and business tax 
accounts. The IRS dependence on this 1960s Master File system today 
constitutes an insurmountable barrier to efficient service and 
compliance operations and is a very serious risk to the whole tax 
system.
    CADE will incrementally move individual filers from the 1960s tape 
system to a modernized database. CADE Individual Master File (IMF) will 
build the database that will replace the existing IMF processing 
systems. CADE will create applications for daily posting, settlement, 
maintenance, refunds processing and issue detection for taxpayer tax 
accounts and return data. The database and applications developed by 
CADE will also enable the development of subsequent modernized systems 
that improve customer service and compliance. Once implemented, 
modernized applications, such as Customer Account Management (CAM), 
will allow on-line posting of data in addition to daily batch 
processing.
    CADE will be deployed over time in five releases, each related to a 
specific taxpayer segment, phased in over a period of six years. At the 
conclusion of Release 5, CADE will have replaced IMF.
Integrated Financial System (IFS)
    IFS has three clear goals: (1) provide core financial capabilities 
and financial reporting; (2) meet Joint Financial Improvement Program 
requirements; and (3) provide an integrated framework for retirement of 
current financial systems.
    IFS will be accomplished in two releases, each representing a 
distinct usable segment. Release 1 will replace the Core Financial 
Systems (CFS) as defined by the Joint Financial Management Improvement 
Program (JFMIP). In addition to CFS, Release 1 will include budget 
formulation as well as implementation of a Cost Accounting System to 
allow the IRS to move into compliance with Statement of Federal 
Financial Accounting Standard Number 4. Release 1 creates a logical 
design for the core financial applications including Cost Accounting. 
The core financial applications consist of General Ledger (G/L), 
Accounts Payable (A/P), Accounts Receivable (A/R), Cost Management, 
Funds Management, Core Financial Management and Financial Reporting.
Custodial Accounting Project (CAP)
    GAO identified the lack of an acceptable accounting system for the 
$2 trillion collected in tax revenue as one of the most significant 
material weaknesses in IRS' financial management. CAP will provide the 
IRS with the critical control and reporting capabilities mandated by 
Federal financial management laws.
    It will also support the appropriate custodial subledgers 
containing data from tax operations and help the IRS meet compliance 
issues with both the Federal Financial Management Improvement Act 
(FFMIA) and Federal mandates related to custodial revenue management. 
CAP will also help us to better manage, control and focus resources.
Enterprise Data Warehouse (EDW)
    The ability of the IRS to make effective use of information about 
its operations is limited by the numerous fragmented databases that 
evolved over time. EDW provides the foundation for data mining and 
decision analytic tools. In addition, it enables risk-based analysis 
for case selection and provides the tools to report on IRS balanced 
performance measures.
e-Services
    The e-Services project will support our ability to meet the overall 
goal of conducting most transactions with taxpayers and their 
representatives in an electronic format, as required by RRA '98. e-
Services will provide to third parties over the Internet the four most 
requested applications: electronic taxpayer identification number 
matching, electronic transcript delivery, disclosure authorization and 
Electronic Account Resolution. e-Services also directly supports the 
President's Management Agenda's governmentwide initiative to expand 
electronic government.
Customer Account Management (CAM)
    The Customer Account Data Engine cannot be deployed beyond its 
initial limited releases without Customer Account Management. CAM 
allows us to go into CADE and update the data and will help taxpayers 
to receive timely and accurate responses to requests and inquiries.
    The CAM Individual Assistance and Self Assistance Operating Models 
will provide improved technology and business processes that will 
enable the IRS to: (1) better manage customer service functions; (2) 
maintain and utilize customer data to improve taxpayer interactions 
with the IRS; (3) provide comprehensive account and tax law assistance 
to taxpayers and practitioners; and (4) manage the case work flow of 
customer inquiries.
    Delivering customer assistance through a live IRS Customer Service 
Representative (CSR) is the Individual Assistance operating model's 
main function. In order to provide world-class service, CSRs must be 
equipped with the tools to access taxpayer information quickly and 
accurately in response to complex customer inquiries. Individual 
Assistance will provide this capability from a desktop information 
system.
    By being able to access and update comprehensive, current account 
information, CSRs will be able to respond quickly and accurately to 
customer inquiries.
    Workflow management tools and processes will also allow them to 
automatically inform relevant parties throughout the organization of 
actions taken on a particular customer's account and manage outstanding 
cases for follow-up work or to identify the status of an inquiry for a 
taxpayer.
    The CAM Self-Assistance operating model delivers many of the same 
capabilities. The main objective, however, is to provide taxpayers with 
the flexibility and convenience of accessing by telephone or the 
Internet on a 24/7 basis IRS-related information to resolve relatively 
simple inquiries.
Filing and Payment Compliance (FPC)
    FPC is an end-to-end strategy to resolve collection issues quickly 
and fairly. Using industry best practices, it augments, refines and 
replaces existing processes and technology to enable the IRS to 
interact with taxpayers in a seamless and efficient manner. Protection 
of taxpayer rights is an important component of this strategy. The 
ultimate goals are to resolve all balance due cases above a minimum 
threshold, shorten the filing compliance lifecycle to ensure resolution 
before the next filing due date and shorten the payment compliance 
lifecycle to six-months for non-enforcement cases.
                    Information Technology Projects
    The Business Systems Modernization program is aimed at developing 
major, IRS-wide systems that are the underpinnings of overall tax 
administration. BSM also sets forth the enterprise architecture that 
defines required standards of equipment, software, communications and 
data. This program is not intended to meet every need for every 
business application in the IRS, even in the long term. However, by 
establishing a well-defined architecture, it assures that specific 
business applications developed for specific business purposes will 
operate consistently and use common equipment while meeting required 
standards, such as security.
    Through the strategic planning process, the IRS operating units 
identify specific business needs and prepare business cases for 
business applications that will not be met through the overall BSM 
process. There are many more projects with high returns than can 
possibly be funded. Therefore through the strategic planning process, 
these are then evaluated and those with the highest returns are 
selected. Many of the gains in performance projected in FY 2003 and FY 
2004 are enabled by these so-called Tier B projects. Tier B project 
implementation time is two to three years and the projects are 
monitored within the Business Performance Review process.
    The President's FY 2003 budget includes a $10 million increase for 
Tier B projects beyond the FY 2002 operating level of $39.8 million. 
They cut across the entire spectrum of IRS activities and functions. 
For example, Information Systems projects will support Criminal 
Investigation's activities by modernizing the equipment used to analyze 
forensic evidence. They will support the electronic filing of business 
forms and schedules and e-Services will provide products and services 
to practitioner as well as the foundation for safe and secure 
electronic customer account management.
    Other projects will redesign and consolidate systems to support 
casework and the Taxpayer Advocate Service. Correspondence will be 
imaged and we will be able to convert existing collection systems to 
electronic case processing. The Employee Plan Determination System 
Redesign will also reduce cycle time and improve the quality of 
determination letters from our Tax Exempt and Government Entities 
operating division. The Remittance Transaction Register will improve 
submission processing efficiency by providing information payment 
online.
             LEGISLATIVE PROPOSALS AND PROPOSED ADJUSTMENTS
                   (No Net Increase in IRS Programs)

    The President's budget requests $503 million (a $39 million 
increase over the FY 2002 appropriation as adjusted) for proposed 
legislative changes that change the accounting of certain pension and 
retiree benefit costs. These costs are transfers of funds that were 
previously included in other agency budgets and do not represent any 
net increases in IRS programs. The $39 million increase will be used as 
follows:

     LFederal Employees' Compensation Act (FECA) Surcharge 
(+$3M). The FY 2003 President's Budget includes language in the General 
Provisions of the Treasury-Postal Appropriations bill to permit the 
Department of Labor to add an administrative surcharge to the amount it 
charges each agency for its Federal Employees' Compensation Act (FECA) 
benefits. Previously this administrative cost was borne by the 
Department of Labor.
     LLegislative Proposal on Full Costing of Retirement and 
Health Benefits (+$32M). The budget also proposes legislation to 
require agencies, beginning in FY 2003, to pay the full government 
share of the accruing cost of retirement for current CSRS, CIA and 
Foreign Service employees, and the Coast Guard, Public Health Service 
and NOAA Commissioned Corps.
     LInter-Departmental Reimbursements (+$5M). This adjustment 
will allow permanent transfers of funds from the General Services 
Administration, the National Archives and Records Administration and 
the Department of Agriculture for services provided to IRS.
                               CONCLUSION
    Mr. Chairman, in conclusion, I believe that we are making steady 
progress on our goals. We are providing improved service to America's 
taxpayer. We have begun to stem the decline in compliance activities. 
And we are doing our job more efficiently and effectively enabling us 
to better leverage our precious resources. Of course, we must measure 
our progress against the larger goals that RRA 98 and we have set for 
ourselves. We still have along way to go.
    So, what must we do to ensure the success of IRS modernization for 
next year and the years beyond? I believe that we must stay focused and 
committed to the intent of the Restructuring Act, making adjustments as 
necessary; but not losing sight of the goal. If we do, I am convinced 
we will succeed.
  
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    Chairman Houghton. Thank you, very much. I will ask Mr. 
Coyne if he would like to ask the first question, but let me 
ask a preliminary one.
    Why do the charts dive south in 2001, particularly in the 
tax law wait and the time index? What happened then?
    Mr. Rossotti. During that period we had an increase in the 
wait time that was due to just the volume of calls relative to 
how fast we were answering them. That drove down service for a 
period of time during 2001. But, as you can see, we have 
dramatically improved that back in 2002.
    Chairman Houghton. Now, the accounts wait time index is a 
little below 100 percent. Now, 100 percent was your goal, is 
that right, for 2000?
    Mr. Rossotti. No, 100 percent is just basically taking 
fiscal year 2000 as the base. This chart shows the increase and 
the decrease from year to year. So in both accounts, wait time 
and account quality had a decrease in fiscal year 2001. It was 
a goal, obviously for this year, to get that back up. It would 
have gone up even more if it were not for the fact, which is 
displayed on the other chart, that the volume of calls in 
February was way over what we expected due to the rate 
reduction credit.
    Chairman Houghton. Thank you very much. Mr. Coyne.
    Mr. Coyne. Thank you, Mr. Chairman. Commissioner, thank you 
for your testimony.
    As was pointed out, you will be leaving toward the end of 
the year the position that you hold now, and I was wondering if 
there was a way you could provide for us any recommendations of 
what the next Commissioner ought to possess in the way of 
qualifications to be picked as the next Commissioner. What 
would you advise to be able to continue the work that has been 
going on at the IRS under your tenure?
    Mr. Rossotti. Actually, I think, as has been publicly 
stated and as is consistent with the Restructuring Reform Act 
(RRA), the IRS Oversight Board, together with the Treasury 
Department, is actually conducting a search, and they have laid 
out criteria for the next Commissioner, and they are well under 
way of doing that. I think the criteria they have put out I 
would agree with.
    They tend to focus on management and leadership 
qualifications predominantly, work in change management in a 
large organization and experience with technology. Those are 
some of the key things that I think they have laid out, and I 
think those are, from my perspective, quite appropriate.
    Mr. Coyne. Based on your experience, would you care to 
comment on what priorities you think a new Commissioner ought 
to emphasize?
    Mr. Rossotti. Well, of course I have a little prejudice 
here, but I really think and I have often said to myself that 
the problem at the IRS is not so much coming up with a vision 
or a concept. As a matter of fact, the commission that 
Congressman Portman cochaired did an excellent job of laying 
out a vision. I think others have similarly laid it out. It is 
more an implementation problem. It is getting it done. I think 
that that is a big job.
    There are a lot of changes that need to be made and a lot 
of technology that is quite complex. We have made some of those 
changes. I think the results are showing that those changes 
have an effect, but they are far from complete. So my view is 
that what is needed is someone who will continue along that 
path and I believe will be able to make way more progress than 
I have been able to make because we had sort of a startup 
period we had to cope with.
    What I think is most important is not to be diverted from 
the task of keeping this vision in mind and really achieving 
the IRS of the future.
    Again, I refer back frequently to the commission report 
because I thought it really laid out what needed to be done. I 
think we are doing that. They are not strange things. They are 
reasonable, obvious things in sort of a broad sense. They 
involve understanding who your customer is, delivering the 
services those customers need, achieving accountability 
internally, and modernizing technology.
    On the enforcement and compliance end, a lot of that has to 
do with making sure you target your resources where the 
problems are and not wasting them on things that are not 
necessary, that you leverage your enforcement people with 
technology. Those things are all laid out. They are all, I 
think, quite powerful. But implementing them is not a small job 
and it does require sustained attention over a period of time.
    So I think over the next Commissioner's term there will be 
some opportunities that will be very exciting to continue on 
this path and to realize the benefits of some of this 
modernization, which I think will deliver. Those lines will 
continue to go up. We didn't have lines on this chart for 
compliance activities and enforcement and the degree to which 
we are being effective in that area, but I think we would show 
some up trends in those areas, too, over the next few years.
    Mr. Coyne. You seem to be recommending implementation of 
things that are already laid out; and, relative to that, I 
would like to ask about the current proposed budget for the 
IRS, where it is at a level of $10.4 billion, a $482 million 
increase over last year. On the other hand, it is $92 million 
lower than what the Oversight Board had recommended. Are there 
things that the Oversight Board saw in recommending that 
additional $92 million that will not be able to be accomplished 
as a result of not having that funding?
    Mr. Rossotti. I think I would be lacking in plausibility if 
I denied we could do more if we had $92 million more. Any 
agency head would say that, and the speed with which we could 
accomplish things would obviously be improved to the extent we 
had more funding.
    On the other hand, I have to say that Secretary O'Neill, in 
a tight budget year, went to bat for us to get us increases in 
both operational funding and modernization funding, and I 
really am appreciative of that.
    The other thing that I want to stress, and I want to put a 
chart up--and I am sorry to be using so many charts, but I hope 
they help to convey some information--one of the key things we 
are trying to do in the IRS, recognizing the budget is always 
going to be significantly limited, is to figure out how we can 
make use of the resources we have, to apply them in a more 
productive way, to free up resources through technology 
especially but also through other management improvements.
    What you can see here from this chart is that what we are 
doing is identifying the highest priority needs for 3,452 full-
time equivalent personnel, which would cost $259 million. That 
is at the top of the chart, and they are just summarized into 
compliance and customer service, primarily. But we knew it 
would be very hard to get that much money in new money, so what 
we have done is identified specifically 2,287 full-time 
equivalent personnel, for a total of $196 million that we are 
going to be able to free up from tasks to apply and to improve 
efficiency to meet those needs. So, basically, that means that 
76 percent of the need is being met through improved efficiency 
and only 24 percent from new resources.
    When we talk about improved efficiency, what do we mean? A 
lot of that is the fruits of modernization and what the 
modernization is all about. E-filing is one example. That is an 
easy one to understand, but not by any means all of it. If you 
get more E-filed returns, you free up people that would 
otherwise just be processing returns and you can use those 
resources for something such as providing better phone service. 
There are dozens of other examples like that.
    As we begin over the next 3 years to realize some of the 
bigger projects that we have in the business of modernization, 
we will continue to improve efficiency. Our strategy is to meet 
most of the needs that we think we will have for additional 
operational resources in order to provide adequate service to 
compliant taxpayers and focus on all those cases of people who 
are not paying what they owe or not reporting what they owe.
    How do we get the resources to do this? Well, part is in 
additional budgetary resources, part of it is freeing up 
resources we already have and to make them more efficient. That 
is what we are attempting to do in this budget. Obviously, the 
more we have, the faster we could get there. But we think we 
have a strategy that will move us on the right path.
    Mr. Coyne. Thank you.
    Chairman Houghton. Thank you, Mr. Coyne. Mr. Portman.
    Mr. Portman. Thank you, Mr. Chairman.
    This is your last testimony before us in this capacity, Mr. 
Commissioner, I understand, and this will be your last filing 
season. You are smiling broadly.
    Chairman Houghton. Well, wait a minute. Let us not be too 
fast. We might ask him to come back.
    Mr. Portman. Maybe we will ask you to come back in your 
private sector capacity and tell us what is really going on.
    I have to say, just to have survived almost 5 years as 
Commissioner of the IRS, you deserve a medal. It is a tough 
job. You took on an agency that was in disrepair. You said it 
started at a low ebb. I think that is an underestimate. We saw 
that earlier by the chart in terms of the public perception, 
but, more importantly, in terms of the actual inefficiencies, 
the lack of computer technology, software, hardware, the lack 
of organizational morale, and an agency that was fraught with 
problems and had been for years. So you have done a good job, I 
believe, in the last 4\1/2\ years in beginning to move the 
agency toward a higher level of service to the taxpayer.
    There are still considerable problems, and you have 
outlined some of them today. My first question to you would be, 
what do you think the single biggest problem is that your 
successor will face?
    Mr. Rossotti. Well, you are limiting me to one, so--I 
answer in terms of our mission, as opposed to the internal 
management. Where we really have significant problems, as the 
Chairman alluded to in his opening statement, is with a 
substantial number of taxpayers who are simply not paying what 
they owe, not reporting what they owe and, in some cases, just 
hiding income. I don't know, because we have not had 
statistics, whether it is worse than it was a few years ago or 
not. But I can tell you that we are getting better and better 
data all the time that tells us this is a very significant 
problem, and it really is something that needs to be addressed, 
not only because of the money that is being lost to the 
Treasury but because of the health of the tax system.
    While addressing this compliance problem, I think we need 
to continue to deliver the proper service to the 90 percent or 
so of the taxpayers who are compliant.
    So I think that being more effective in addressing some of 
these compliance issues is an important goal.
    Now, that is in terms of mission. If I go back and say what 
do we need to do to accomplish those compliance goals, I come 
back to the fact that modernization really does have something 
to do with that. Some people have a perception that technology 
modernization is only useful as a way of supporting 
improvements in service to taxpayers, to compliance services, 
to telephone service and electronic filing. I think that is not 
a correct perception. Because some of the very same 
modernization projects that we are working on are going to 
support improvement in our ability to conduct compliance 
operations as well as service operations. I could go into more 
detail about it, but they really support more effectiveness and 
more efficiency across the board in the whole agency.
    Mr. Portman. The fruits of modernization, which is one of 
the three or four key pillars of your tenure, as you look back 
on your legacy, would probably be the restructuring itself, 
literally restructuring the IRS to focus on the individual 
taxpayer. It would be the entirely new formulation of how to 
measure performance rather than how much money you squeeze out 
of the taxpayer, how much service you are providing. It would 
probably be the modernization, as we said, of the computer 
system?
    Mr. Rossotti. Those are the three.
    Mr. Portman. And that will relate not just to better 
taxpayer service--and we still have a ways to go there, but we 
have made substantial improvements--but also being able to 
target enforcement and to be able to use existing enforcement 
personnel more efficiently?
    Mr. Rossotti. Exactly.
    Mr. Portman. That seems to me to be probably the biggest 
challenge.
    Just a couple of recent reports trouble all of us. As you 
know, the Oversight Board recently did a survey which indicated 
that from 1999 until today there has been a substantial erosion 
in people's sense as to the acceptability of cheating on taxes. 
We have also got a recent report that there are 2 million 
taxpayers who have offshore credit cards who are trying to hide 
income through that. So I think it is more than a perception 
problem.
    Although that is out there, it may be that there are some 
noncompliance problems that need to be focused on. But what I 
hope we will not take from this is that the improvements that 
have been made in terms of taxpayer service, modernization, and 
restructuring are mutually exclusive with increased compliance 
enforcement. I think, as you do, that they go hand-in-hand.
    I am also disturbed by some of the analysis recently 
indicating that somehow you cannot have decent service for the 
taxpayers and at the same time have a system which enforces 
this voluntary compliance system in an appropriate way. I think 
the two go hand-in-hand, and I think the fruits of your labor 
may not be seen for a couple of years.
    You said in response to Mr. Coyne that you expect to see up 
trends over the next few years on enforcement and compliance.
    Mr. Rossotti. Yes.
    Mr. Portman. Is that correct?
    Mr. Rossotti. I do. Of course, part of that is dependent on 
budget resources. But, actually, our goal last year was to 
stabilize. They had been going down not just for the last 2 
years but for many years, all of the indicators, audit rates 
and all the statistical indicators. We knew that, obviously, 
couldn't continue, and we were successful in most cases, not in 
all, to generally level those off last year. We hope to see 
some modest increases on a purely statistical basis this year 
and next year due partly to this reallocation of resources.
    But I do want to stress--and I think this is important in 
your statement, Mr. Portman--it is not just statistics. People 
ask what is the right audit rate. Well, how do we know whether 
\1/2\ of 1 percent is the right number or 1 percent? We really 
don't. But what we do know is when we can identify, which we 
are now starting to be able to do much more specifically, where 
are the cases, do we have names of people that are not paying 
or underreporting, whether that be because they have not paid 
what is owed or they have not reported or they have hidden 
income. We are starting to get this information. When we do, we 
will be able to use our enforcement resources very effectively 
to target those who are really not complying.
    I agree with you that it is a false dilemma to believe that 
you are either providing good service to taxpayers or you are 
doing good enforcement. Most of the taxpayers that are wanting 
to comply, which is where we get most of our money, we do not 
need enforcement for them because they are already complying, 
with maybe a modest amount of encouragement, sometimes in the 
form of a notice or a phone call, they will pay and comply. But 
there are other taxpayers, fortunately a small percentage but 
still a large number in absolute terms, who are not complying, 
who are not paying or are hiding income or are using various 
kinds of abusive devices or who are just basically cutting 
corners.
    I think, while we need to respect the rights of those 
taxpayers, as is indicated in the RRA, I think we view that 
when we take enforcement action against those taxpayers we are 
on the side of the honest taxpayer.
    So the important thing is to understand your customer base 
and understand what is the appropriate treatment for each type 
of customer, and that is where the new restructuring of our 
organization is making us more effective.
    Mr. Portman. Thank you, Mr. Commissioner. My time is up, 
but I hope that thinking succeeds you. We look forward to 
working with you over the next several months.
    It should be noted that this Subcommittee worked on the 
Restructuring Reform Act and came up with a system where there 
would be an oversight board that had 5-year staggered terms, so 
there is expertise on that board as well as accountability with 
that board, but also importantly, as you transition, 
continuity. So there will be people on that board who have gone 
through this process with you, at least through the last few 
years, once they finally got up and going, and those people 
will continue. We hope that you will work with them to be sure 
the transition is indeed smooth.
    Thank you, Mr. Chairman.
    Chairman Houghton. Thank you. Mrs. Thurman.
    Mrs. Thurman. Thank you, Commissioner, for being here, and 
thank you for your service. I know that you personally have 
tried to continue to bring the IRS into this new decade here, 
and we appreciate that. I know it has been tough, because you 
have not always been given the resources necessary.
    In fact, I have to tell you in one of our papers at home 
today they actually said we ought to be helping you with some 
resources. But at the same time they actually also are 
editorializing and asking some questions about the New York 
Times article, that was, I guess, on Sunday, specifically, 
``Wealthy Taxpayers Avoiding IRS Audits Despite Warnings That 
Cheating Is on the Rise.''
    Something we have heard about over and over in this 
Committee is the Earned Income Tax Credit, and I noticed in the 
suggestions by The Taxpayers Advocate and yourselves on the 
bill we will potentially be taking up tomorrow is that there 
will be recommendations as to how do you define, what do we do 
differently, and how do we get better compliance. So I guess 
the question I have for you is, if we can bring compliance or 
talk about compliance from the standpoint of what we are going 
to do with the Earned Income Tax Credit, can you give me 
suggestions as to how we might get to the lost taxes on this 
partnership income, which has not been included in this 
Taxpayers Bill of Rights tomorrow?
    I think it is important for us to understand that and know 
that, because it is my understanding that if we just spent an 
additional $9 million in auditing tax returns from these 
partnerships we could recover somewhere around $1.8 billion, if 
this number is correct. But I would be curious if you could 
give us any ideas of what we ought to be doing in tomorrow's 
bill to help us.
    Mr. Rossotti. As a matter of fact, that is one of our top 
priorities. Because you are quite right and the article is 
right. I don't know about those specific numbers, but there has 
been an enormous growth in the last 10 or 15 years in the use 
of partnerships, trusts and S corporations, which are flow-
through type organizations. But they all have the same type of 
characteristics, where the taxes are paid not at the entity 
level but by the owners. There has been growth not only in the 
number of these pass through organizations but also the total 
amount of income that flows through them, and it is really 
quite substantial.
    It is also accurate that the IRS was not keeping up with 
that on the whole. We really recognized that point about 2 
years ago; and, in fact, in the budget request for 2001, there 
was some request specifically for some additional funding to 
take one of the steps that we think is necessary, which is to 
begin matching the K-1 documents. The K-1s are the documents 
that are reported to the shareholders or the partners of these 
entities.
    Mrs. Thurman. Did you receive those dollars? I don't 
recall.
    Mr. Rossotti. Pardon me?
    Mrs. Thurman. Are you doing that now?
    Mr. Rossotti. Yes. We got that money, and we have started 
to do that. I do stress it was only the starter kit for the 
money, because it was only what we needed for the matching, and 
we will have more cases that flow out of the information we 
gain from this program.
    In fact, I was out at one of our centers just 2 weeks ago 
where they are starting to do K-1 matching, and we will begin 
to get cases out of that which will show us whether people are 
not reporting some of that pass through income.
    This is only one technique. The other thing we are doing is 
focusing on another part of this problem, which is use of 
devices, especially trusts, as an abusive tax evasion device. 
People set up and promote, in some cases, various schemes where 
the idea is that if you are, let's say, a businessperson or a 
professional of some sort, for example a medical professional 
or even a lawyer, you allegedly transfer your business to one 
of these trusts and have multiple layers of them taking out 
various kinds of expenses at each layer. In some cases, people 
actually incorporate the trust in a tax haven, which is more 
aggressive aspect of tax avoidance, so that the income is 
actually moved offshore completely. This is, we think, one of 
the most significant of the actively promoted schemes that 
people are using to hide income.
    We began about 2 years ago, as was laid out in our 
strategy, to reallocate resources to this problem. This means 
not only the K-1 matching, which is one strategy, one 
technique, but also training field agents. We, frankly, had a 
small number of agents trained to do this work. So we began to 
train people to do this.
    We also tried some techniques that are now starting to pay 
off, such as issuing summonses to get at the money hidden 
offshore. We issued a summons, initially, to one of the major 
credit card companies to give us records that had been issued 
by banks in some of these tax havens to people who were 
spending money in the United States. This was one of the 
techniques being used to repatriate the money. We started that 
2 years ago, and we are now starting to get some rather 
substantial information out of it.
    Also, if you have seen the papers, we issued some 
additional summonses to other credit card companies, and we are 
finding that there are very significant numbers of taxpayers 
who seem to be taking advantage of this device to put income 
overseas in tax havens.
    I don't mean to imply that everybody using a trust or an S 
corp, by any means, is using them to hide income, but there are 
some who are. And even the ones who are not have a lot of 
income going through there, which we had not been paying as 
much attention to as we should have.
    It is unfortunate that it takes a little bit of time to 
crank up these initiatives. It just does not happen overnight, 
because there are quite a few steps that you have to go 
through. But I am, I think, pleased that we are now at a point 
where we are starting to see some of the things come out of the 
pipeline on this; and over the next 2 years, if we can continue 
this, I think this will be a very, very important compliance 
initiative.
    Mrs. Thurman. I am trying to help you give a response to 
this, too, but, in saying all of that, one of the things that 
the paper reported was that, ``When unreported partnership 
income is found, the IRS will send notices demanding taxes or 
an explanation, but the IRS was given no additional money for 
the actual casework,'' I guess to follow up, ``when unreported 
income is found.''
    Is that accurate? And if it is, are there recommendations?
    We are going to take this bill to the floor tomorrow. I 
don't know how much we can change tomorrow, but certainly it 
has another body to go through that we should be expediting 
this.
    This is my concern. These are the kinds of articles that, 
when people don't feel that they are being treated fairly, will 
undo everything that you have tried to do. And when you have 
got somebody out there working, who doesn't get to take their 
health care expenses off, who doesn't get to take their travel 
expenses off, who doesn't get their lunch expensed, but gets 
hit 1 out of every 45 times, versus somebody who is having that 
advantage, that is not going to be a good report. And I don't 
want that to be the report that we hear about IRS. I would 
rather hear the other issues.
    But I am concerned that some of these low and middle income 
payers are going to feel like their government is working only 
for those that have more than those who have less.
    Mr. Rossotti. I could not agree with you more. I have 
stated that numerous times. We feel we are on the side of the 
honest taxpayer, the ones you are talking about, the person who 
really does pay their taxes. That is why we have taken the 
resources that we have and begun to refocus them as strongly as 
we can on these larger amounts and, in some cases, more 
egregious forms of noncompliance and the use of these trusts 
and partnerships as a technique to do that.
    Again, I want to stress that most of them are very 
legitimate, and most people that use partnerships are doing 
them very appropriately, but there is a significant amount that 
are not.
    Mrs. Thurman. We agreed with you on that on the Earned 
Income Tax Credit. But it always seems every time we get in 
this debate, the Earned Income Tax Credit was the bad guy. Now 
we are hearing there is another story out there.
    Mr. Rossotti. The truth is, as I see it after being in this 
job, there is noncompliance at all levels and of all kinds. 
Taxpayers at all levels comply, and there is a minority of 
taxpayers who abuse the system at all levels, too. What I 
believe we should do is be as effective as we can in finding 
those cases at all levels and especially those that are more 
egregious and are larger and use our resources for them.
    Now, on the question about our not getting more money for 
these cases, initially this was in the 2001 budget. We went for 
the money necessary in order to do the matching. We didn't know 
how many cases were going to come out of that. We did not 
specifically request the money for that. However, in the 2003 
budget, there is money in this highest priority needs.
    You will notice the biggest part of this, this 1857 (FTEs, 
full-time employees) for compliance, some of these will be what 
we would use to do those kinds of cases.
    Mrs. Thurman. Thank you.
    Chairman Houghton. Mr. Weller.
    Mr. Weller. Thank you, Mr. Chairman.
    Commissioner, good to see you today. Welcome back before 
our Subcommittee. I would like to focus on the Electronic Tax 
Administration.
    Of course, the Restructuring Reform Act of 1998 set a goal 
for the IRS to have 80 percent of returns filed electronically 
by the year 2007; and, while you have made progress, the U.S. 
General Accounting Office (GAO) and the Electronic Tax 
Administration's Advisory Committee said you may not be on 
track to achieve that 80 percent goal. Can you report on what 
kind of progress you are making toward this 80 percent goal, 
where you are today and where you expect to be?
    Mr. Rossotti. Yes, I can; and let me tell you exactly. We 
set a goal this fiscal year--and I am going to speak of the 
1040s now, the individual returns--of 46 million electronically 
filed, which was a 15-percent increase over last year and which 
was actually a million more if you just did a statistical trend 
line. And I am pleased to say that, based on the results as 
late as yesterday, that I think we will not only meet the 46 
million but we expect to go over the 46 million. So 46 million 
would be a 15-percent increase, and we will probably come close 
to a 16-percent increase, which is a greater increase than we 
had last year.
    Now, if you extrapolate that all the way out to 2007, we 
would actually need a little bit higher rate of increase to 
reach 80 percent. We would actually need 19 percent. The reason 
for that is because we not only have to reach 80 percent of the 
returns currently being filed but the number of returns grows 
every year. There is about a 1.8 percent a year growth in the 
number of returns. So between 1998 and 2007, where Congress set 
the goal at 2007, when this goal comes in there will be 
actually 20 more million returns filed than in 1997, due to the 
increase in the number of filers.
    The bottom line is, we are close to the track but not quite 
on the track; and I think that is why the provision that this 
Committee reported out concerning setting the filing date, 
which the Administration had proposed and the Committee 
supported, I think is an important step. We need some steps 
like that to give us that little more boost we need to get up 
to the 80 percent level. We are close to it with the percentage 
that we have this year.
    Mr. Weller. As you pointed out, the President proposed 
extending the deadline to April 30, essentially 2 weeks beyond 
the deadline, if you file electronically. We, of course, had 
moved legislation a few weeks ago out of this Committee for 
that purpose, and I expect we will be voting on it within the 
week. From your standpoint of administering this, how will that 
help you?
    Mr. Rossotti. I think it will help us and the taxpayer, by 
giving an incentive, for the taxpayers who file late, to file 
electronically.
    See, if you were to look at the percentage of returns we 
have gotten in today, we are already getting a majority. If you 
looked at it as of this minute, April 9th, the majority of 
returns that have come in so far have been filed 
electronically. The problem is the ones that come in late are 
usually filed on paper, and those are also the most expensive 
ones to handle.
    Why do the later returns come in on paper predominantly? 
One of the reasons is because more of them, obviously, have 
balances due with the returns, as opposed to refunds. Clearly, 
there is more of an incentive to get in quicker if you get a 
refund. So that is one reason.
    Well, the later filing date and the payment date would give 
an incentive for those people.
    Finally, there are just procrastinators. Some of us will 
procrastinate even when we are getting a refund. And the fact 
this gives you 2 weeks more to file gives you an opportunity to 
get your return in on time even later. So I think those are the 
reasons. It would give an incentive for people who would file 
in the last, say, week of the filing season and who have 
balance due returns to file electronically.
    We have done analysis of this and have, through market 
research, determined that we would tap a significant block of 
taxpayers that would otherwise not be tapped. And I think by 
adding that to the growth that we otherwise would have, it 
would definitely boost it, and it would also be a benefit to 
the taxpayers because they would have that much longer.
    Mr. Weller. It will be interesting to see how this 
experiment works come May.
    Mr. Rossotti. I am quite confident it will work. I think 
there are a few practitioners who are concerned about extending 
the filing season, but I think from the point of view of the 
taxpayer it will be a benefit.
    Mr. Weller. Commissioner, in talking about the issue of 
convenience, some State agencies allow tax filings based on a 
Web-based application, which means that the taxpayer has no 
need to purchase software or to download software; and, of 
course, there is no cost in doing that. I was wondering, is the 
IRS considering offering any similar Web-based filing options?
    Mr. Rossotti. First, let me point out one thing. There are 
a number of options that a taxpayer can use for filing on the 
Web from various commercial providers that then transmit to us, 
although they usually charge a fee, usually about $10 or so to 
do that. So the service is available, but it is available 
through tax preparation software companies. And in the 
Administration's budget for this year, proposed by the 
President, there is an initiative to try to find a way to work 
with the private sector, to find a way to offer that service to 
at least some block of taxpayers in a way that will be either 
at no cost to the taxpayer or more accessible to the taxpayer.
    As a matter of fact, we have an active program under way 
right now working with the software industry, some of whose 
members are here, I know, in the audience, to try to find a way 
to implement the Administration's proposal. The objective of 
that would be to do exactly as you say, without stepping into 
the problem that we really don't want to step into of getting 
the IRS into being a software provider. We have enough trouble 
with our own software.
    Mr. Weller. Well, Commissioner, there would be, I believe, 
certainly in the House, would be significant concern, if you 
were to put yourself in a position where you are competing with 
the private sector which is offering this service. And I would 
note that at least one company I know of who does provide this 
software at no cost to low income families to help them. I know 
they have done that in communities that I represent.
    Mr. Rossotti. What we are trying to do is exactly build on 
those kind of offerings, but make them something that we could 
make a little bit more accessible and maybe something that the 
IRS could join with the industry in publicizing. Right now we 
are very limited in what we can do to let them know about it.
    Mr. Weller. I would ask if you could keep us informed if 
you move forward on any initiative and keep the Members of this 
Subcommittee informed on what you may be doing.
    Mr. Chairman, may I have one additional question?
    Chairman Houghton. Yes.
    Mr. Weller. Thank you, Mr. Chairman.
    It has also been reported that the IRS may be delaying 
refunds on electronically filed returns. And, of course, as we 
have just discussed, many taxpayers find it convenient to file 
electronically, and we want to encourage taxpayers to file 
electronically.
    Can you explain why there is a delay in providing refunds 
to those who filed electronically?
    Mr. Rossotti. The answer is there is no difference in the 
way that we evaluate filings, whether they are filed on paper 
or electronically. We have made that commitment many times 
because we don't want to discriminate in any way between people 
that file electronically or that file on paper.
    We do have various screening devices to hold certain 
refunds based on the risk that there could be a problem with 
those refunds. But those screening tools are applied equally to 
paper and electronic returns. I know that some people get the 
impression that if they had a refund that was frozen for a 
compliance reason, and it happened to be filed electronically, 
people will sometimes include that, the refund was held because 
the return was filed electronically.
    If the same exact return had been filed on paper, it would 
have been held for the same reasons, because we apply the same 
filters, if you will, to those returns.
    Mr. Weller. So you are saying that refunds for paper filing 
versus electronic filing are essentially treated the same if 
received in the same period of time?
    Mr. Rossotti. Well, it takes a while longer for the paper 
to go through the system. But, I mean, we have--as part of our 
processing in order to identify potentially invalid or 
incorrect refunds, we have various screening devices. And that 
includes some that are aimed at finding potential fraudulent 
refunds, because we do get submissions for fraudulent refunds. 
We have a set of techniques that we apply to try to identify 
those. But those techniques are applied after the return is 
submitted. They are applied equally to both kinds.
    Mr. Weller. What is the average period of time between 
electronic filing and someone receiving a refund?
    Mr. Rossotti. On an electronic filing, you typically get 
your refund in 10 to 14 days. On paper it is about 6 weeks.
    Mr. Weller. Thank you, Mr. Chairman. Thanks for the 
courtesy of an additional couple of minutes.
    Chairman Houghton. Mr. Commissioner, I would like to ask 
you a couple of questions. The reason, I understand it, that 
the lower income returns are monitored more than the higher 
income returns is because it is easy to match. Now, the 
question is, in terms of real estate trusts, in terms of 
partnerships and things like that, is it going to be easier to 
be able to put your hands on those issues? Whereas, you have 
never been able to get information as far as the K-1 or the 
forms sent to partnerships? Talk a little bit about that.
    Mr. Rossotti. Could I clarify a few terms here, because I 
think one of the things that gets a little confusing is what is 
an examination.
    We publish statistics on what percentage of people are 
examined. And an examination has a specific definition in the 
Code, in our Internal Revenue manual. It basically has to do 
with us requesting or requiring a taxpayer to submit books and 
records to us. But we have a huge range of what we call an 
examination. Most of the examinations, almost all of the 
examinations of the earned income tax credit population, which 
is funded under a separate appropriation, I should note, are 
very, very simple exams, which have to do with--basically can 
be conducted by letter, almost all cases. We call them 
correspondence exams. They are very simple and usually they 
involve us sending a letter to the taxpayer and requesting them 
to send us substantiation for certain information about why 
they claimed a certain child as a qualifying child under the 
earned income credit or why they claimed, for example, head of 
household status, you know.
    Those examinations are relatively low cost to do, because 
all they involve is sending a letter and getting information 
back. And we do a significant number of those in quantity 
because we have a large number of earned income tax credit 
claims that come in.
    One of those is counted as an exam the same as an exam 
where we might send a revenue agent out to audit a high income 
individual and spend several weeks in their office actually 
auditing their books and records. They are still counted as one 
exam. So when you look at these statistics, they really are not 
necessarily revealing in and of themselves. You have to look 
behind them.
    We do audit, in terms of pure numbers, a significant number 
of earned income tax credit taxpayers. But, in terms of the use 
of our resources it represents, I believe it is something like 
6 percent of our total audit resources.
    Chairman Houghton. Can I just interrupt here a minute? 
Maybe I am not making myself clear. I guess what I am getting 
at is, you have the source of income which is taxable, and 
another way of checking it, that it is easy to sort of monitor 
so that there is a trust, a truthfulness going on here. If you 
have only have one statement, it is very difficult to do that. 
I mean, for example, with gross receipts on the Schedule C, or 
cost of assets sold or things like that. So how do you get 
around that?
    Mr. Rossotti. Well, basically, if you look at individual 
returns, about 75 to 80 percent of the total income, and I am 
only looking at income now that is reported on individual 
returns, is reported by a third party, what you are referring 
to. Okay? So for that purpose we can use matching techniques 
and other kinds of techniques for that.
    The business income, and this includes some income that 
comes in through Schedule Cs as well as other sources, there is 
no third party source.
    So the only way that you can verify that income is to go 
out and check the books and records of the taxpayer, which is 
one of the reasons we need audits, to be able to check those 
kinds of records. Now, some of the income that has increased 
that is coming in, and this is heavily concentrated in upper 
income individuals, does come in through partnerships and 
trusts on these K-1s. That is an opportunity. It is reported 
through a third party. And we can match that. It was not 
previously being matched until starting fairly recently. But we 
are now starting to use that. So the answer is that we need a 
variety of techniques. We use obviously the most efficient one. 
Where we can match documents, we do. And that is a very 
efficient way to verify income. Where we cannot match 
documents, we need to go out and check books and records.
    Chairman Houghton. Let me--the overall question which I 
wanted to ask you is this, and then maybe some of the others 
will have some additional questions. In terms of your 
priorities, if I were sitting in your seat, there would be 
three issues. One would be tax simplification. Two is moving 
from a pencil and pad form to an electronic system. The third 
is buttressing up this concept of trust and truth.
    And, you know, it has been touched upon by so many people. 
And I guess the thing that worries me is that I don't know 
whether we are leveling off, if the trend is going to go up or 
we are continuing down, because the difference between the 
survey information in 1999, I guess it was, and what it was in 
2001 is a big difference, big drop.
    And I think one of the things that has always impressed me 
about our system is that there is an understanding of the value 
literally of paying taxes in order to be able to supply those 
things which our government needs and our people need. And 
there is a trusting relationship there. And I just don't know 
what the underlying erosion is. You may want to make a comment.
    Mr. Rossotti. Well, let me just say that I think I totally 
agree with you that the total system depends on trust, and it 
depends on the belief that people who are paying are not 
getting victimized or taken for suckers by someone who is 
getting away with it. There is indication, you know, that 
although I don't know how reliable that is, that there may be 
some erosion in that.
    I do want to point out that we began an initiative called 
the National Research Program which we have briefed many 
Members of the Committee on, which was sorely needed, in my 
opinion, to actually to get a real handle quantitatively and to 
measure who is paying and who is not paying, who is reporting, 
I should say, and who is not reporting. And that, you know, was 
long overdue. The last time that was done was in 1988. It will 
take us about 2 years. We are starting it this year. But it 
will take us to the end of next year, end of 2003 to get that. 
That information, I think, will be extremely valuable in 
helping us to measure whether there is an erosion, not only in 
sort of surveys, but in actual behavior of taxpayers and will 
also help us to pinpoint where the most serious problems are. I 
must say we are not waiting for this survey. We know there are 
compliance problems. We have got cases, and we have got 
millions of them that we can work right now. So we are not 
waiting for the survey. But, in order to get the point of what 
the trend is and whether there is an erosion, I think we do 
need some information that we don't have right now. And we are 
going to get it. We are going to get it reasonably soon by our 
standards, which means possibly by the end of 2003.
    Chairman Houghton. All right. Let me ask you, have you got 
any questions, Mrs. Thurman?
    Mrs. Thurman. Commissioner, just--based on just what the 
Chairman said and your response to me, and looking at the 
budget and particularly where you put the highest priority 
resource needs in compliance, and to help build this trust with 
the American public that we are talking about, would it be safe 
to say then that under the 2003 budget that we might see an 
increased auditing and/or individuals on partnerships and 
overseas trusts similar to what we see in the 1 out of every 45 
working poor that are subjected? Can we get to those numbers?
    Mr. Rossotti. Well, I got--you are definitely going to see 
an increase. But we are not going to wait until 2003. We are 
actually going to see an increase this year. The statistics, 
frankly, are not comparable, because we are talking about a 
letter audit versus something much more complicated. To give 
you an example, it can take us 300 to 500 hours of actual 
direct audit time to audit an individual with an offshore 
account. That can be a couple of hundred times as long as it 
takes to do this other audit. So these are not the same. There 
is a lot more money at stake. Frankly, just counting audits 
doesn't tell you a whole lot.
    But I think what is important is looking at what we are 
doing with that audit and what we are targeting. I could not 
agree with you more. We need to target those resources where 
people are really abusing the system.
    Mrs. Thurman. I think that once we target some of them, we 
may not have so much abuse in the system.
    Mr. Rossotti. I hope not.
    Mrs. Thurman. Thank you.
    Chairman Houghton. Just one final question.
    You know, this is such an important time. Not only in terms 
of what you have done, the way the IRS has turned, but some of 
these huge problems out there. I am going to request that we 
might have another go at this thing prior to you leaving, maybe 
in October, so that you can give your final swan song and we 
can make--make absolutely sure what you think are important as 
you move along these next 5 years.
    Mr. Rossotti. I would be delighted, Mr. Chairman. I would 
be honored to do that.
    Chairman Houghton. Thank you very much. Appreciate it.
    We will now have the next panel. Mr. James L. White, 
Director of Tax Policy and Administration Issues, U.S. General 
Accounting Office, and Colleen Kelly, National President, 
National Treasury Employees Union. Will you please come to the 
stand? Thank you.
    All right. Well, Mr. White, will you begin your testimony. 
Thank you very much. And, Ms. Kelly, nice to see you.

       STATEMENT OF JAMES R. WHITE, DIRECTOR, TAX ISSUES,

                 U.S. GENERAL ACCOUNTING OFFICE

    Mr. White. Mr. Chairman and Members of the Subcommittee. I 
am pleased to participate in your review of IRS' budget request 
and filing season performance. I would like to begin by 
commending IRS for several actions.
    First, IRS used its new strategic planning, budgeting and 
performance management process to identify internal savings 
that it expects will allow it to redirect over 2000 staff to 
higher priorities.
    Second, unlike past years, IRS' request for business 
systems modernization funding is grounded in analyses that meet 
the requirements for such capital investment funding.
    Third, with one major exception, the processing of returns 
this filing season has gone smoothly and there have been some 
improvements in telephone service.
    Having said that, we have several cautions and concerns 
regarding both the budget request and filing season 
performance. One important caution about the budget request is 
that it is based on a series of assumptions that can prove 
optimistic, a result, to some extent, of the fact that budgets 
are prepared in advance.
    The assumptions include the likelihood that the savings of 
over 2000 staff years that I just mentioned will be realized 
and there will be no major unexpected expenses. Unrealized 
savings or unexpected expenses could lead to cutbacks in 
planned hiring; cutbacks that historically have hit IRS' 
enforcement programs the hardest.
    In addition, IRS' budget request does not always provide an 
adequate link between the resources requested and what IRS 
proposes to accomplish with its resources. In some cases, such 
as telephone service, good links exist. IRS asked for $14 
million for additional staff and projects to increase the 
percentage of callers getting assistance by about 5 percentage 
points.
    However, in other areas linkages are not adequate. For 
example, IRS asked for additional resources to fight systematic 
noncompliance such as abusive trusts and failure to pay 
employment taxes. But it is unclear how many resources will be 
devoted to each problem or what results are expected. Thus, it 
will be difficult to judge progress or hold IRS accountable. 
Consequently, the Subcommittee may want to ask IRS for more 
specifics about spending in areas with inadequate linkages to 
projected results.
    In addition, IRS requests a continuation of the separate 
appropriation for earned income credit compliance. Considering 
other compliance problems facing IRS, the Subcommittee may want 
to ask IRS for its views on the value of this separate 
appropriation for the credit versus a combined appropriation 
for all compliance programs.
    A third concern about the budget is the lack of 
justification for $1.63 billion for operation and maintenance 
of information systems. Rather than assess the costs, benefits 
and risks of specific projects, an approach taken by leading 
private and public organizations, IRS officials said they 
simply took last years spending and added an amount to fund 
cost of living and salary increases.
    While we cannot tell from the budget information whether 
any spending cuts are justified, we are recommending that 
future information system budget requests be in accordance with 
leading organization practices.
    On a related matter, this year's investment and business 
systems modernization, we have reported our concerns about the 
number and complexity of systems acquisition projects and the 
continued lack of certain management controls and capabilities. 
In response, IRS has committed to align the pace of the program 
with the maturity of management controls and is reassessing 
projects it plans to deploy in 2002.
    Now, I want to discuss the filing season. This year, the 
one exception to the smooth processing of returns has been the 
large number of errors taxpayers are making related to the rate 
reduction credit and advance refund checks sent out last summer 
and fall. Although the errors have not affected the timeliness 
of processing, they have resulted in a significant error 
correction workload for IRS, the rejection of some 
electronically filed returns, and an increased demand for 
telephone assistance that is affecting taxpayers' access to 
IRS' assisters.
    So far, about 7 percent, or over 3 million of the returns 
filed to date, contain such errors. Although IRS took steps to 
deal with the problem, in retrospect, IRS may have been able to 
prevent some of the errors if the instructions on tax returns 
had been clearer.
    A key question related to filing season performance is 
whether IRS is improving its performance management so it will 
be better able to improve future performance. To this end, IRS 
has some useful performance measures but misses certain 
important aspects of service to taxpayers. For example, IRS 
does not have a measure of the service it provides to about 70 
million callers who use its automated telephone services. At 
your request, Mr. Chairman, we are reviewing IRS' filing season 
performance measures and plan to issue a separate report on our 
results.
    Mr. Chairman, that concludes my statement. I would be happy 
to answer any questions.
    [The prepared statement of Mr. White follows:]
    Statement of James R. White, Director, Tax Issues, U.S. General 
                           Accounting Office
    Mr. Chairman and Members of the Subcommittee:
    We are pleased to participate in the Subcommittee's inquiry into 
the fiscal year 2003 budget request for the Internal Revenue Service 
(IRS) and the 2002 tax filing season.
    As you requested, our statement assesses the support for various 
aspects of IRS' budget request, including the linkage between resources 
requested and expected results, and IRS' performance in processing 
returns and providing assistance to taxpayers during this filing 
season.
    Our assessment is based on (1) our review of IRS' fiscal year 2003 
budget request and supporting documentation; (2) the preliminary 
results of our review of the 2002 tax filing season; and (3) past and 
ongoing reviews of various IRS activities, including those related to 
information systems and performance measures.\1\
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    \1\ Some of our analysis is based on data provided by IRS that we 
did not verify. These data generally came from management information 
systems that we have used in the past to assess IRS operations.
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    IRS is requesting about $10.4 billion for fiscal year 2003, an 
increase of about $500 million, or about 5 percent, over its 
appropriated level of about $9.9 billion for fiscal year 2002.\2\ The 
proposed request is expected to fund 101,080 full-time equivalent (FTE) 
staff years, an increase of 1,179 FTEs over 2002. In addition to the 
increase of 1,179 FTEs, IRS identified internal savings that it expects 
will allow 2,287 FTEs to be redirected to higher-priority areas. To 
identify these savings, IRS used its recently implemented strategic 
planning, budgeting, and performance management process. This process 
is designed to reconcile competing priorities and initiatives with the 
realities of available resources. We commend IRS for using this process 
to reassess the allocation of resources in its base budget for 2003. 
With respect to IRS' request, our statement makes the following points:
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    \2\ These dollar amounts include funding for the legislative 
proposal on full costing of retirement and health benefits. Absent that 
legislation, the fiscal year 2003 budget would be $9.9 billion, an 
increase of $445 million over fiscal year 2002.

     LIRS' plans for hiring and redirecting staff depend on 
several assumptions that could be optimistic--a natural result, to some 
extent, of the fact that budgets are prepared so far in advance of the 
fiscal year involved. These assumptions include (1) labor and nonlabor 
savings of 2,287 staff years and $157.5 million identified by IRS 
operating units and (2) additional savings of $38.5 million resulting 
from better business practices that have not yet been identified. Also, 
IRS may face some unanticipated expenses, such as a larger civilian pay 
raise than proposed by the Administration, that could, if not funded, 
affect IRS' financial plan for 2003. Unrealized savings or unexpected 
expenses could lead to cutbacks in planned hiring--cutbacks that 
historically have hit IRS' enforcement programs the hardest.
     LIRS' congressional justification does not always provide 
an adequate link between the resources being requested and IRS' 
performance goals. In some respects, such as with telephone service, 
good links exist. In other areas, however, there are either no 
performance goals against which Congress can hold IRS accountable or 
there appear to be inconsistencies between the resources being 
requested and the expected change in performance or workload. The 
Subcommittee may want to pursue these issues with IRS.
     LAlthough IRS provided adequate support to justify the 
$450 million request for its multiyear capital account for business 
systems modernization, it did not adequately support $1.63 billion of 
the $1.68 billion requested for its information systems. The $1.63 
billion is for the operation and maintenance of existing (legacy) 
systems. We are recommending to IRS that it prepare its fiscal year 
2004 information systems budget request in accordance with the 
practices of leading private and public sector organizations.

    Our testimony on the 2002 filing season presents interim data on 
IRS' performance in processing returns and helping taxpayers who call 
IRS or walk into an IRS office. The following two themes predominate:

     LSo far this filing season, IRS has processed returns 
smoothly, with one major exception, and seen continued growth in 
electronic filing. The one exception to smooth processing has been the 
large number of errors taxpayers are making related to the rate 
reduction credit. IRS has had to correct millions of returns with 
errors related to the credit, and taxpayers' calls about the credit 
have greatly increased the demand on IRS' toll-free assistance lines, 
likely causing IRS' overall level of telephone service to dip 
significantly for a few weeks during the filing season. Some of these 
errors may have been avoided if the instructions for the income tax 
forms had been clearer.
     LIRS' performance measures provide useful information on 
which both IRS and we rely to assess its success in assisting 
taxpayers. However, some measures of telephone service are constructed 
in a way that miss important aspects of the activity being measured, 
and plans to begin measuring some important aspects of IRS' walk-in 
service have been delayed.
IRS' Budget Request for Fiscal Year 2003
    If IRS' budget request is approved, IRS will have more than 3,400 
staff years that can be assigned to new or existing activities in 
fiscal year 2003. These include the 1,179 additional staff years 
requested in the budget and the 2,287 staff years that IRS determined 
could be redirected elsewhere in the organization due to projected 
savings from several improvement projects and workload decreases. These 
3,400 staff years can make a real impact on IRS' performance if they 
are targeted to selected areas. However, the availability of these 
staff years depends on the projected savings being realized and no 
significant unanticipated expenses. In addition, it is difficult to 
evaluate the effect that these additional and redirected staff years 
will have on IRS' operations because the budget is not well-linked to 
performance goals in some important areas.
    With respect to that part of the budget request for information 
technology, IRS (1) did not adequately support the $1.63 billion 
requested for operation and maintenance of its information systems but 
(2) did adequately support its $450 million request for business 
systems modernization.
IRS' Budget Request Is Based on Several Assumptions
    IRS' fiscal year 2003 budget request is based on several 
assumptions that could prove optimistic. These include (1) labor and 
nonlabor savings of 2,287 staff years and $157.5 million from various 
improvement projects and workload decreases that IRS plans to use 
elsewhere in the organization, and (2) additional savings of $38.5 
million resulting from better business practices that have not yet been 
identified. Also, IRS may face some unanticipated expenses that, if not 
funded, could cause it to revise its financial plan for fiscal year 
2003. In many respects, this kind of uncertainty is the natural result 
of a process that requires the development of budget estimates many 
months before the fiscal year in question. No matter the reason, the 
end result could be unrealized savings or unexpected expenses that, as 
in the past, lead to cutbacks in planned hiring--cutbacks that 
historically have hit IRS' enforcement programs the hardest.
    Through use of its strategic planning, budgeting, and performance 
management process, IRS identified a myriad of expected efficiency 
improvements, technological enhancements, labor-saving initiatives, and 
workload decreases that it projects will enable it to redirect $157.5 
million in its base budget to higher-priority areas. Examples include 
(1) saving over $67 million from re-engineering and quality improvement 
efforts, such as consolidating form printing and distribution 
operations and updating an antiquated workload selection system to 
reduce or eliminate the substantial number of tax returns that are 
ordered but never audited, and (2) reducing the resources used for the 
innocent spouse program by $13.8 million due to an expected decrease in 
caseload.
    We commend IRS for taking the initiative to reassess the allocation 
of resources in its base budget. However, the congressional 
justification submitted by IRS in support of its budget request does 
not explain how IRS developed the labor and nonlabor savings. IRS 
provided us with information on the overall method used to develop the 
savings and explained that, in a change from IRS' previously used top-
down process, operating units determined the resource increases and 
decreases their programs needed. However, IRS did not provide details 
on how specific savings were computed, such as information on any 
assumptions used in developing specific estimates.
    In response to the secretary of the Treasury's challenge for each 
Treasury bureau to review all programmatic efforts and reduce or remove 
those producing little or no value, IRS officials estimated that such a 
review could save $38.5 million. IRS' congressional justification notes 
that the secretary considers this review to be a work in progress and 
expects bureau heads and financial plan managers ``to work creatively 
on mid-course adjustments'' until the final quarter of fiscal year 
2003. Accordingly, the congressional justification provides no details 
on how the $38.5 million will be achieved.
    Any shortfall in the estimated labor and nonlabor savings or in 
savings from efforts to reduce or eliminate programs will only be 
exacerbated if IRS has to absorb unanticipated budget increases. For 
example, IRS officials estimated that it would cost an additional $69 
million if the civilian pay raise included in this budget was increased 
to achieve parity with the proposed pay raise for the military.\3\ In 
fiscal year 2002, IRS faced unbudgeted cost increases related to rent, 
pay raises, security, and postage rate increases. As a result, IRS had 
to delay hiring revenue agents and officers, tax compliance officers, 
and tax specialists. According to IRS, ``the lack of full funding for 
non-labor inflation over the years has greatly reduced the IRS ability 
to cover pay raise costs and other legitimate cost increases by 
reducing non-labor costs, leaving the IRS with the sole alternative of 
reducing staff.'' IRS noted that ``these budget constraints forced the 
IRS to reduce 1,364 FTEs in the [fiscal year] 2002 plan.'' Although we 
do not have specific evidence of how this FTE reduction affected IRS' 
operations, IRS data does indicate that the number of revenue agent 
FTEs in its current financial plan for fiscal year 2002 (11,836) is 691 
fewer than the actual revenue agent FTEs in fiscal year 2000 (12,527)--
despite funding of an initiative in fiscal years 2001 and 2002 that, 
among other things, was to increase the number of revenue agent FTEs.
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    \3\ The Administration proposed a 2.6-percent pay increase for 
civilian employees in fiscal year 2003, which is the percentage IRS 
used in developing its budget, and a 4.1-percent pay raise for military 
personnel.
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Congressional Justification Not Always Well-Linked to Performance Goals
    The Government Performance and Results Act of 1993 requires 
agencies to establish linkages between resources and results. With this 
requirement, Congress hoped to focus agencies on achieving better 
results for the American public. Congress also hoped to gain a better 
understanding of what is being achieved in relation to what is being 
spent.
    In some respects, IRS' congressional justification has good links 
between the resources being requested and IRS' performance goals. For 
example, IRS' budget includes an increase of 213 FTEs and $14.1 million 
to improve its telephone level of service, and its performance measures 
show an expected increase in toll-free telephone level of service from 
71.5 percent in fiscal year 2002 to 76.3 percent in fiscal year 2003.
    However, in other important areas, the congressional justification 
is not well-linked to performance goals. In some instances, there are 
no performance goals against which Congress can hold IRS accountable. 
In other instances, there seem to be inconsistencies between the amount 
of resources being requested and the expected change in performance or 
workload.
    Missing Performance Goals
    A significant example of missing performance goals involves IRS' 
efforts to address major areas of systematic noncompliance. In February 
2002, the commissioner of Internal Revenue identified four such areas: 
(1) misuse of devices, such as trusts and passthroughs, to hide income; 
(2) use of complex and abusive corporate tax shelters to reduce taxes 
improperly; (3) failure to file and pay large accumulations of 
employment taxes; and (4) erroneous refund claims, which include claims 
made under the Earned Income Credit (EIC) program. The budget request 
includes increased resources for compliance but, except for the EIC 
program, it is unclear from IRS' congressional justification how many 
resources IRS intends to devote to each of these problems. And, for 
none of these areas, including the EIC program, does the congressional 
justification include performance measures and goals that Congress can 
use to assess IRS' progress in addressing these major compliance 
problems.
    IRS' congressional justification is clear about the amount of 
resources IRS plans to devote to EIC compliance efforts because the 
budget request calls for the continuation of a separate appropriation 
for that program. If approved, it will be the sixth year of targeted 
funding for the EIC program. IRS' compliance efforts under this program 
have prevented the payment of hundreds of millions of dollars of 
improper EIC claims. However, the most recent IRS information shows 
that the rate of EIC noncompliance is still very high. According to 
IRS' report on its analysis of EIC compliance rates on tax year 1999 
returns filed in 2000, (1) about one-half of the 18.8 million returns 
on which taxpayers claimed the EIC involved overclaims and (2) of the 
estimated $31.3 billion in EIC claims made by taxpayers who filed 
returns in 2000, between $8.5 billion and $9.9 billion should not have 
been paid.
    Audit coverage is another area where performance goals would help 
Congress assess IRS' progress. IRS states in its congressional 
justification that it will increase the resources for stabilizing audit 
rates by 368 FTEs and $24 million. Although the congressional 
justification states that audit rates have fallen, the justification 
does not include any information about current audit rates or what 
rates IRS expects to achieve in 2003.
    Issue for Congressional Oversight
    Given the amount of resources that could be involved in dealing 
with the four major compliance problems cited by the commissioner and 
increasing overall audit coverage, the Subcommittee may want to ask IRS 
to provide (1) more specifics on the level of resources it plans to 
devote to each of these areas and its performance measures and goals 
for each area and (2) its views on maintaining a separate appropriation 
for the EIC versus combining in one appropriation those resources with 
the resources being requested for other compliance work, which could 
give IRS more flexibility in deciding how best to allocate its 
resources among all of its compliance needs.
    Inconsistencies between Budget Request and Performance Goals
    The budget request and performance goals included in the 
congressional justification are, at times, inconsistent. Some of those 
inconsistencies might suggest that additional resources beyond those 
identified by IRS are available for redirection. Specific examples of 
inconsistencies include the following:

     LA requested increase of 476 staff years and $20.7 million 
for ``increased Offer-in-Compromise cases'' is inconsistent with IRS' 
performance goal for that program, which shows that the number of cases 
processed is expected to decrease from 185,000 in 2002 to 104,600 in 
fiscal year 2003. This requested increase also conflicts with our 
recent evaluation of the program that shows that IRS projected that the 
number of staff years needed would decrease from 1,818 in fiscal year 
2002 to 1,224 in fiscal year 2003.\4\ In response to our question about 
this, IRS officials said that the staff year increase is to replace 
revenue officers who currently handle the cases so there is not a net 
increase in staff years for the offer program. This does not help 
explain why IRS is asking for an increase in resources when the 
workload is expected to decline and IRS had projected a decreased need 
for staff in the program.
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    \4\ U.S. General Accounting Office, Tax Administration: IRS Should 
Evaluate the Changes to its Offer in Compromise Program, GAO-02-311 
(Washington, D.C.: Mar. 15, 2002).
---------------------------------------------------------------------------
     LAccording to IRS' budget request, the field and 
electronic/correspondence exam units will receive about the same number 
of staff years as the year before, while in terms of dollars, the field 
exam unit will receive an increase of less than 3 percent and the 
electronic/correspondence unit will receive an increase of about 7 
percent. However, IRS' performance measures show the field exam unit is 
expected to examine 33 percent more individual returns and almost 35 
percent more business returns while the electronic/correspondence unit 
is expected to increase the number of correspondence examinations by 32 
percent. It is not clear from the congressional justification how IRS 
expects to do so much more work with just a small increase in 
resources. IRS told us that one reason for the apparent inconsistency 
is that correspondence audits run on a 2-year cycle, with a high number 
of case starts in one year and a large number of case closures in the 
next year.
     LIRS' budget request includes an additional 197 staff 
years and $8.3 million for processing a projected growth in the total 
number of primary returns filed from about 225.9 million returns in 
fiscal year 2202 to about 230.0 returns in fiscal year 2003. However, 
according to IRS' performance measures, that projected growth is the 
net of an increase of about 7.6 million returns filed electronically 
and a decrease of about 3.4 million returns filed on paper. That 
decline in the more costly to process paper returns would seem to argue 
against the need for additional processing resources. In response to 
our question about this, IRS acknowledged that the number of paper 
returns was expected to decline but said, nonetheless, that its 
computation of the number of additional FTEs needed was ``based on an 
estimate of direct hours needed to process expected paper returns.''
    Issue for Congressional Oversight
    Because the congressional justification provides inadequate 
information to explain the apparent inconsistencies discussed in the 
preceding section and because, in some respects, those inconsistencies 
suggest that additional resources might be available for redirection to 
other purposes, the Subcommittee may want to ask IRS for additional 
information in support of those parts of its budget request.
Justification for Information Technology Budget Request Needs 
        Improvement
    IRS is requesting $2.13 billion and 7,449 staff years in 
information technology (IT) resources for fiscal year 2003. This 
includes (1) $450 million for the agency's multiyear capital account 
that funds contractor costs for the Business Systems Modernization 
(BSM) Program, which is adequately justified, and (2) $1.68 billion and 
7,449 staff years for information systems, of which $1.63 billion for 
operations and maintenance is not adequately justified. With respect to 
the $1.63 billion request for operations and maintenance, IRS was 
unable to provide sufficient support for us to identify possible budget 
reductions.
    Fiscal Year 2003 BSM Request Is Adequately Justified
    Key provisions of the Clinger-Cohen Act, the Government Performance 
and Results Act, and Office of Management and Budget (OMB) guidance on 
budget preparation and submission (e.g., Circular No. A-11) require 
that, before requesting multiyear funding for capital asset 
acquisitions, agencies develop sufficient justification for these 
investments. This justification should reasonably demonstrate how 
proposed investments support agency mission operations and provide 
positive business value in terms of expected costs, benefits, and 
risks.
    Since the BSM appropriation was established in fiscal year 1998, we 
have consistently reported that IRS has not developed adequate 
justification for its budget requests, and we have proposed that 
Congress consider reducing them.\5\ During this same time, we have 
repeatedly recommended \6\ that IRS put in place an enterprise 
architecture (modernization blueprint) to guide and constrain its 
business system investments.\7\ Use of such a blueprint is a practice 
of leading public and private sector organizations. Simply stated, this 
architecture provides a high-level roadmap for business and 
technological change from which agencies can logically and justifiably 
derive their budget requests and capital investment plans. In response, 
IRS has developed various versions of an enterprise architecture, which 
we have continued to review and make recommendations for improvement 
in. IRS recently approved a new version of this architecture (version 
2.0), which, based on a briefing to us and others, appears to provide 
robust descriptions of IRS' current and target business and technology 
environments. IRS has also drafted, and executive management is 
reviewing, the associated high-level transition plan that identifies 
and conceptually justifies needed investments to guide the agency's 
transition over many years from its current to its target architectural 
state.
---------------------------------------------------------------------------
    \5\ U.S. General Accounting Office, Tax Administration: IRS' 2000 
Tax Filing Season and Fiscal Year 2001 Budget Request, GAO/T-GGD/AIMD-
00-133 (Washington, D.C.: Mar. 28, 2000); Tax Administration: IRS' 
Fiscal Year 2000 Budget Request and 1999 Tax Filing Season, GAO/T-GGD/
AIMD-99-140 (Washington, D.C.: Apr. 13, 1999); Tax Administration: IRS' 
Fiscal Year 1999 Budget Request and Fiscal Year 1998 Filing Season, 
GAO/T-GGD/AIMD-98-114 (Washington, D.C.: Mar. 31, 1998); Tax 
Administration: IRS' Fiscal Year 1997 Spending, 1997 Filing Season, and 
Fiscal Year 1998 Budget Request, GAO/T-GGD/AIMD-97-66 (Washington, 
D.C.: Mar. 18, 1997).
    \6\ See, for example, GAO/T-GGD/AIMD-97-66; U.S. General Accounting 
Office, Tax Systems Modernization: Blueprint Is a Good Start But Not 
Yet Sufficiently Complete to Build or Acquire Systems, GAO/AIMD/GGD-98-
54 (Washington, D.C.: Feb. 24, 1998); and GAO/T-GGD/AIMD-00-133.
    \7\ An enterprise architecture provides an institutional 
``blueprint'' for defining how an organization operates today (baseline 
environment), in both business and technological terms, and how it 
wants to operate in the future (target environment). It also includes a 
sequencing plan that provides a roadmap for transitioning between these 
environments.
---------------------------------------------------------------------------
    IRS' $450 million request is based on its enterprise architecture 
as well as related life cycle management and investment management 
process disciplines for its ongoing project investments. As such, this 
request is grounded in analyses that meet the statutory and regulatory 
requirements for requesting multiyear capital investment funding.
    Pursuant to statute,\8\ funds from the BSM account are not 
available for obligation until IRS submits to the congressional 
appropriations committees for approval an expenditure plan that meets 
certain conditions.\9\ In November 2001, IRS submitted its fifth 
expenditure plan seeking approval to obligate the $391 million 
remaining in the BSM account at that time. In briefings to the relevant 
appropriations subcommittees and IRS, we reported our concerns about 
the escalating risk that IRS will be unable to deliver promised BSM 
system capabilities on time and within budget due to the number and 
complexity of ongoing and planned systems acquisition projects and the 
continued lack of certain key modernization management controls and 
capabilities.
---------------------------------------------------------------------------
    \8\ The Treasury and General Government Appropriations Act of 2002 
(P.L. 107-67).
    \9\ IRS' BSM expenditure plans are required to (1) meet OMB capital 
planning and investment control review requirements; (2) comply with 
IRS' enterprise architecture; (3) conform with IRS' enterprise life 
cycle methodology; (4) be approved by IRS, Treasury, and OMB; (5) be 
reviewed by us; and (6) comply with the acquisition rules, 
requirements, guidelines, and systems acquisition management practices 
of the Federal Government.
---------------------------------------------------------------------------
    In approving the expenditure plan, the appropriations subcommittees 
directed IRS to reconsider the scope and pace specified in the November 
2001 expenditure plan to ensure that the number and complexity of 
modernization projects underway is commensurate with IRS' management 
capacity and fully establish and implement all process controls needed 
to effectively manage the modernization effort prior to the submission 
of IRS' next expenditure plan.
    In response to these and other concerns raised by the 
appropriations committees and us, IRS has committed to aligning the 
pace of the BSM program with the maturity of the organization's 
management controls and management capacity and is currently conducting 
a reassessment of the projects it plans to deploy during fiscal year 
2002. In addition, IRS has taken appropriate steps toward implementing 
missing management controls.
    IRS' Information Systems Request for Operations
    and Maintenance Is Not Adequately Justified
    Leading private and public sector organizations have taken a 
project or system-centric approach to managing not only new investments 
but also operations and maintenance of existing systems. As such, these 
organizations:

     Lidentify operations and maintenance projects and systems 
for inclusion in budget requests;
     Lassess these projects or systems on the basis of expected 
costs, benefits, and risks to the organization;
     Lanalyze these projects as a portfolio of competing 
funding options;
     Land use this information to develop and support budget 
requests.

    This focus on projects, their outcomes, and risks as the basic 
elements of analysis and decisionmaking is incorporated in the IT 
investment management approach recommended by OMB and us.\10\ By using 
these proven investment management approaches for budget formulation, 
agencies have a systematic method, based on risk and return on 
investment, to justify what are typically very substantial operations 
and maintenance budget requests. These approaches also provide a way to 
hold IT managers accountable for operations and maintenance spending 
and the ongoing efficiency and efficacy of existing systems.
---------------------------------------------------------------------------
    \10\ See, for example, U.S. General Accounting Office, Information 
Technology Investment Management: A Framework for Assessing and 
Improving Process Maturity, Exposure Draft, GAO/AIMD-10.1.23 
(Washington, D.C., May 2000, Version 1).
---------------------------------------------------------------------------
    IRS did not develop its information systems request in accordance 
with these best practices of leading organizations. In particular, the 
largest elements of IRS' budget request are not projects or systems. 
Rather, they are requests for staffing levels or other services. For 
example, IRS is requesting $240 million for staff and equipment 
supporting operations and maintenance of desktop computers agencywide, 
as well as $111 million for staff and equipment supporting its major 
computing centers' operations. Further, it is requesting $266 million 
for telecommunications services contracts. Taken together, these three 
initiatives constitute about 38 percent of the total $1.63 billion 
being requested for operations and maintenance, but the budget request 
gives no indication regarding how these initiatives are allocated to 
systems. In addition, in developing these requests, IRS did not 
identify and assess the relative costs, benefits, and risks of specific 
projects or systems in these areas. Instead, according to IRS 
officials, they simply took what was spent last year in the categories 
and added the money to fund cost-of-living and salary increases.
    IRS officials responsible for developing the IT operations and 
maintenance budget attributed the differences between IRS practices and 
those followed by leading organizations to the lack of an adequate cost 
accounting system, cultural resistance to change, and a previous lack 
of management priority. To better justify future budget requests, these 
officials said that they have assessed the strengths and weaknesses of 
IRS' budgeting and investment management processes against our IT 
investment management framework \11\ and found significant weaknesses 
in 15 critical areas. To address the weaknesses, IRS is currently 
developing capital planning guidance based on our IT investment 
management framework. This guidance is to be issued by late summer 
2002, but a schedule for implementing it has yet to be determined. In 
addition, IRS has adopted and is in the process of implementing a cost 
model that is to enable it to account for the full costs of operations 
and maintenance projects and determine how effectively IRS projects are 
achieving program goals and mission needs. IRS plans to have the cost 
model in place and operational by June 30 of this year so that it can 
validate its fiscal year 2003 information systems appropriation request 
and begin using it to develop the fiscal year 2004 request.
---------------------------------------------------------------------------
    \11\ GAO/AIMD-10.1.23.
---------------------------------------------------------------------------
    The key to making these plans reality is overcoming the very 
reasons that have allowed this budgetary formulation and justification 
weakness to continue unabated--accounting system limitations, cultural 
resistance, and low management priority. Although IRS has initiated 
actions to address these weaknesses, we are concerned whether they will 
be implemented in time to have meaningful impact on formulation of the 
fiscal year 2004 budget request. For example, IRS has not yet developed 
a plan and schedule for implementing its IT capital planning guidance. 
In addition, IRS officials told us that they are already beginning the 
process to develop the fiscal year 2004 budget. Consequently, until IRS 
overcomes its obstacles, its future information systems appropriation 
requests, like its fiscal year 2003 request, will not be adequately 
justified.
Recommendation for Executive Action
    To aid IRS in overcoming the barriers to changing how it develops 
and justifies its information systems appropriation request, we 
recommend to the commissioner of internal revenue that IRS prepare its 
fiscal year 2004 information systems budget request in accordance with 
leading organizations' best practices.
Interim Results of IRS' 2002 Filing Season
Show Impact of the Rate Reduction Credit
    So far this filing season, IRS has processed returns smoothly with 
one major exception, seen continued growth in electronic filing, and 
achieved some improvements in telephone service. The one exception to 
smooth processing has been the large number of errors taxpayers are 
making related to the rate reduction credit. Although the errors have 
not affected the timeliness of processing, they have resulted in a 
significant error correction workload for IRS, the rejection of some 
electronically filed returns, and an increased demand for telephone 
assistance that, according to agency officials, is affecting taxpayers' 
access to IRS' telephone assistors. One issue that continues to affect 
IRS' ability to assess its filing season performance is missing 
performance measures. While IRS has measures that provide useful 
information on some aspects of its service and is making efforts to 
improve its performance measures, some measures of telephone service 
are constructed in a way that misses important aspects of the activity 
being measured and IRS has delayed implementation of some accuracy 
measures for services provided at walk-in offices.
Errors Related to the Rate Reduction Credit Have Adversely
Affected an Otherwise Smooth Processing Season
    This filing season, IRS experienced very few of the kinds of 
processing problems, such as those caused by computer programming 
errors, that it has often experienced at the beginning of a filing 
season, and the number of returns filed electronically continues to 
grow. The one major negative in this otherwise positive picture has 
been the significant number of returns IRS has received with errors 
related to the rate reduction credit.
    The Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 
No. 107-16) directed the Secretary of the Treasury to issue advance tax 
refunds to eligible taxpayers. Accordingly millions of taxpayers 
received checks of up to $600 between July and December 2001. Taxpayers 
who did not receive an advance refund as part of that process or who 
received less than the maximum allowed by law may have been entitled to 
a rate reduction credit when filing their tax year 2001 returns in 
2002. Accordingly, IRS added a line to the individual income tax forms 
for eligible taxpayers to enter a credit amount and provided a 
worksheet for taxpayers to use in determining if they were eligible. So 
far, during the 2002 filing season, the rate reduction credit has led 
to millions of tax returns with errors.
    The result has been significant error-correction workloads for IRS 
and a large increase in the number of error notices sent to taxpayers. 
In retrospect, at least some of these errors might have been avoided if 
IRS had taken certain steps to better help taxpayers deal with this new 
tax return line item. One of the steps IRS took to deal with the large 
number of errors related to rate reduction credit was to reject certain 
electronic submissions involving rate reduction credit errors. Even so, 
electronic filing has continued to grow--although not at a rate that 
would allow IRS to meet its long-term goal.
    Millions of Returns Filed with Errors Related to the Rate Reduction 
        Credit
    As Table 1 shows, of the approximate 46 million returns that IRS 
had processed as of March 15, 2002, about 4.7 million, or 10 percent, 
had errors made by taxpayers or their return preparers--more than twice 
the error rate at the same time last year but roughly comparable to the 
error rate IRS expected. Of the approximate 4.7 million returns with 
errors, about two-thirds, or 3.1 million, had errors related to the 
rate reduction credit.

 TABLE 1:  PROCESSED RETURNS WITH RATE REDUCTION CREDIT ERRORS MADE BY TAXPAYERS OR RETURN PREPARERS AS OF MARCH
                                                    15, 2002
----------------------------------------------------------------------------------------------------------------
                                                                                                         Rate
                                                                             Number of   Percentage   reduction
                                       Number of    Number of   Percentage    returns    of returns     credit
         Returns prepared by            returns      returns    of returns   with rate   with rate   errors as a
                                       processed      with     with errors   reduction   reduction    percent of
                                                     errors                   credit       credit      returns
                                                                              errors       errors    with errors
----------------------------------------------------------------------------------------------------------------
Taxpayers                              17,778,234   2,638,705         14.8   1,506,932          8.5         57.1
----------------------------------------------------------------------------------------------------------------
Tax return preparers                   28,172,854   2,042,626          7.3   1,613,689          5.7         79.0
----------------------------------------------------------------------------------------------------------------
Total                                  45,951,088   4,681,331         10.2   3,120,621          6.8         66.7
----------------------------------------------------------------------------------------------------------------
Note: Because some returns could contain errors related to the rate reduction credit as well as other errors, a
  decrease in the number of rate reduction errors would not necessarily equate to a like decrease in the overall
  number of returns with errors.
Source: GAO-generated from IRS data.

    Taxpayers and return preparers are making various types of errors 
related to the rate reduction credit. Many taxpayers who did not 
receive an advance of their rate reduction credit in 2001 and thus 
should be claiming the credit on this year's return, are not. Other 
taxpayers are recording the amount of the credit they received in 2001 
on the rate reduction credit line of this year's return instead of 
recording zero. And other taxpayers, who are entitled to a credit and 
are claiming one, are incorrectly computing the amount to which they 
are entitled.
    Once IRS recognized that taxpayers and preparers were having 
problems with the rate reduction credit, it took immediate action in an 
attempt to minimize future errors and avoid refund delays. IRS posted 
information to its Web site, began a public awareness campaign that 
included news releases to media outlets, and provided clarifying 
information to preparers who file returns electronically. Despite IRS' 
efforts, the rate at which taxpayers and return preparers are making 
errors related to the rate reduction credit has remained relatively 
constant.
    Because IRS anticipated an increase in errors this year and because 
IRS has been able to correct the rate reduction errors relatively 
quickly, we are not aware of any adverse impact on IRS' ability to 
process returns and refunds in a timely manner as a result of the 
increased error-correction workload. IRS is treating these errors as 
``math errors''; that is, it corrects the mistake and either adjusts 
the taxpayer's refund or notifies the taxpayer of additional tax owed. 
However, it remains to be seen what happens around April 15, when the 
largest volume of paper returns are filed. Even if IRS is able to 
effectively correct the large volumes of erroneous returns throughout 
the filing season, there are costs involved, including the cost of 
generating and mailing several million error notices to affected 
taxpayers and the costs of the resources IRS had to devote to working 
the increased error-correction workload.
    IRS May Have Been Able To Prevent Some Rate Reduction Credit Errors
    Although IRS took several steps after the filing season began in 
response to the large number of rate reduction credit errors, we 
believe, in retrospect, that some of those errors might have been 
prevented if the instructions for Forms 1040, 1040A, and 1040EZ had 
been more clear. For example, IRS did not highlight the rate reduction 
credit or the new line on the tax form related to the rate reduction 
credit on the cover page of the instructions, where IRS alerts 
taxpayers to changes from the prior year. Instead, IRS highlighted the 
fact that tax rates were reduced. Only if taxpayers read the paragraph 
under the highlighted caption ``Tax Rates Reduced'' would they see 
mention of the credit.
    The instructions for Forms 1040, 1040A, and 1040EZ might have also 
been clearer if IRS had included some information that was included on 
its Web site. In that regard, the instructions indicate that if a 
taxpayer received--before any offset--an amount equal to either $600, 
$500, or $300 based on his or her filing status, the taxpayer is not 
entitled to a rate reduction credit. There is no further explanation of 
the term ``before any offset''--a term that may be unclear to many 
taxpayers. However, IRS' Web site spells out more clearly what is meant 
by this term, explaining that if taxpayers had their advance payment 
offset to pay back taxes, other government debts, or past due child 
support, they cannot claim the rate reduction credit for the amount 
that was offset. Although the Web site includes this more descriptive 
information, there is no guarantee that a given taxpayer either has 
access to or will use the Web site. In retrospect, including the same 
explanation of ``before any offset'' in the instructions would have 
made the instructions clearer.
    Use of Electronic Filing Continues to Grow, but
    not at a Pace to Achieve IRS' Long-Range Goal
    Another step IRS took that has reduced its error-correction 
workload due to the rate reduction credit was to begin rejecting 
electronic submissions that involved certain types of errors related to 
the credit. By doing so, IRS required the taxpayer or return preparer 
to correct the error before IRS would accept the electronic return. 
This is consistent with IRS' traditional practice of rejecting 
electronic submissions that contain other errors, such as incorrect 
Social Security numbers. IRS began rejecting electronic submissions 
with errors involving the rate reduction credit around the beginning of 
February. As of March 24, 2002, IRS had rejected about 226,000 such 
submissions.
    We do not know whether these rejected submissions caused potential 
electronic filers to file instead on paper. However, as shown in Table 
2, the number of individual income tax returns filed electronically as 
of March 29, 2002, has grown by 14.0 percent--an increase over the rate 
of growth at the same time last year. While this kind of increase is 
not insignificant, IRS will need larger increases in the future if it 
is to achieve its goal of having 80 percent of all individual income 
tax returns filed electronically by 2007.\12\
---------------------------------------------------------------------------
    \12\ As noted in our report on the 2001 filing season, assuming 
annual growth rates of 13.7 percent for individual income tax returns 
filed electronically and 1.85 percent for the total number of 
individual income tax returns filed (the growth rates experienced in 
2001), about 60 percent of all individual income tax returns will be 
filed electronically in 2007. See U.S. General Accounting Office, Tax 
Administration: Assessment of IRS' 2001 Tax Filing Season, GAO-02-144 
(Washington, D.C.: Dec. 21, 2001).

                             TABLE 2:  INDIVIDUAL INCOME TAX RETURNS RECEIVED BY IRS
                                         (Number of returns in millions)
----------------------------------------------------------------------------------------------------------------
                                                                    Percentage                      Percentage
           Filing type            1/1/00 to 3/31/ 1/1/01 to 3/30/  change: 2000   1/1/02 to 3/29/  change: 2001
                                        00              01            to 2001           02            to 2002
----------------------------------------------------------------------------------------------------------------
Paper                                      40.9            37.2            -9.1            35.5            -4.7
----------------------------------------------------------------------------------------------------------------
Electronic
----------------------------------------------------------------------------------------------------------------
  Traditional a                            21.4            24.0            12.3            26.9            12.1
----------------------------------------------------------------------------------------------------------------
  On-line b                                 3.5             4.8            36.4             6.7            39.4
----------------------------------------------------------------------------------------------------------------
  TeleFile c                                4.4             3.7           -14.7             3.5            -6.6
----------------------------------------------------------------------------------------------------------------
  Subtotal                                 29.3            32.6            11.2            37.1            14.0
----------------------------------------------------------------------------------------------------------------
Total                                      70.2            69.7            -0.6            72.6             4.1
----------------------------------------------------------------------------------------------------------------
Note: Subtotals, totals, and percentages may not compute due to rounding.
a Traditional electronic filing involves the transmission of returns over communication lines through a third
  party, such as a tax return preparer, to an IRS processing center.
b On-line returns are prepared and transmitted by the taxpayer through an on-line intermediary using a personal
  computer and commercial software.
c Under TeleFile, certain taxpayers who are eligible to file a Form 1040EZ are allowed to file using a toll-free
  number on touch-tone telephones.
Source: IRS data.

    To encourage more electronic filing in 2002, IRS, among other 
things:

     Lmailed letters to about 250,000 tax professionals, asking 
those who had been filing electronically to continue supporting the 
program and encouraging others to file electronically;
     Lmailed about 23 million postcards to certain taxpayers, 
such as those who had received TeleFile packages in the past 2 years 
but did not file their tax returns via TeleFile, alerting them to the 
benefits of electronic filing; and
     Lmade changes to one program that enabled electronic 
filers to sign their returns using a personal identification number 
(PIN) and reinstituted another PIN-based signature program.\13\
---------------------------------------------------------------------------
    \13\ IRS efforts to increase the use of PINs and thus avoid the 
need for electronic filers to send signature documents to IRS has had a 
positive effect. As of March 14, 2002, about 17.1 million individual 
returns were filed using a PIN--about 180 percent more than the 6.1 
million filed for the same time period in 2001.

    IRS also redirected its marketing efforts to encourage persons who 
have been preparing tax returns on a computer but filing on paper to 
file electronically. Considering that about 40 million computer-
prepared returns were filed on paper in 2001, conversion of those 
returns to electronic filings could go a long way toward helping IRS 
achieve its 80-percent goal. In our report on the 2001 filing season, 
we recommended that IRS directly survey tax professionals and taxpayers 
who file computer-prepared returns on paper to get more specific 
information on why they are not filing electronically.\14\ We have been 
told that IRS will be undertaking such a survey in the near future.
---------------------------------------------------------------------------
    \14\ GAO-02-144.
---------------------------------------------------------------------------
IRS Has Experienced Some Improvements in Telephone Service, but the 
        Rate Reduction Credit Is Likely Affecting Taxpayers' Access
    So far this filing season, taxpayers in the queue for telephone 
assistance are spending less time waiting to talk with an assistor and 
are getting accurate answers to their tax law questions more often than 
last year. At the same time, however, the overall rate at which callers 
are reaching an assistor is lower because many callers are unable to 
get into the queue for assistance.
    Telephone assistance is a significant part of IRS' work. This 
fiscal year, IRS expects to answer about 108 million telephone calls, 
about 72 million to be answered via automated services and about 34 
million to be answered by about 10,000 full- and part-time telephone 
assistors, called customer service representatives. Accordingly, the 
ease with which taxpayers reach IRS by telephone and the accuracy of 
the assistance they receive are important indicators of how well IRS is 
performing. IRS' performance in providing this service has been a 
perennial problem, and its struggles to improve service have been a 
topic at hearings held by this Subcommittee for many years. As we 
reported in December 2001, IRS has made limited progress toward its 
long-term goal of providing taxpayers ``world-class customer 
service''--service comparable to the best provided by other 
organizations.\15\
---------------------------------------------------------------------------
    \15\ U.S. General Accounting Office, IRS Telephone Assistance: 
Limited Progress and Missed Opportunities to Analyze Performance in the 
2001 Filing Season, GAO-02-212 (Washington, D.C.: Dec. 7, 2001).
---------------------------------------------------------------------------
    Some Improvements in Accessibility and Accuracy
    In recent years, IRS has made significant strides in developing 
performance measures to tell how well it is serving taxpayers by 
telephone. IRS has established a set of measures to focus efforts on 
enhancing taxpayers' access to accurate assistance. As shown in Table 
3, some of these measures indicate significant improvements in taxpayer 
service when compared to the same period last year. For example, during 
the first 11 weeks of the 2002 filing season:

     Ltaxpayers, on average, waited a minute-and-a-half less to 
speak to an assistor,
     Lthere was an 18 percentage point improvement in taxpayers 
reaching assistors in 30 seconds or less, and
     Lthe quality of tax law assistance, which involves 
following IRS procedures and providing accurate responses, improved 
about 11 percentage points.

    However, there was a 5-point decline in the percentage of callers 
that attempted to reach an assistor and actually got through and 
received service (referred to as the customer service representive 
(CSR) level of service). According to IRS officials, an increased 
demand for assistance related to the rate reduction credit has been a 
key factor affecting taxpayer access to assistors. (See Appendix I for 
more detail on the level of access this filing season compared to last 
and the likely impact of the rate reduction credit.) The increased call 
volume was not allowed to lengthen the queue. Instead, taxpayers were 
provided access to automated services, which often results in callers 
hanging up, or were advised by a recorded message that IRS could not 
provide assistance.

  Table 3:  Telephone Assistance Performance in the First Weeks of the
                      2001 and 2002 Filing Seasons
------------------------------------------------------------------------
                  Measure a                       2001          2002
------------------------------------------------------------------------
Accessibility measures
------------------------------------------------------------------------
CSR level of service b                                 71%           66%
------------------------------------------------------------------------
Assistor response level c                              39%           57%
------------------------------------------------------------------------
Abandon rate d                                         16%           13%
------------------------------------------------------------------------
Average speed of answer e                      299 seconds   209 seconds
------------------------------------------------------------------------
Accuracy measures
------------------------------------------------------------------------
Tax law quality rate f                          70%  2%     minus> 1%
------------------------------------------------------------------------
Accounts quality rate f                         71%  2%     minus> 2%
------------------------------------------------------------------------
Tax law correct response rate g                 75%  2%     minus> 1%
------------------------------------------------------------------------
Accounts correct response rate g                87%  2%     minus> 1%
------------------------------------------------------------------------
a Accessibility measures are based on actual counts from January 1
  through March 16. Accuracy measures are based on representative
  samples and are estimated at the 90-percent confidence level from
  January through February.
b This measure is intended to show the percentage of callers who wanted
  to speak to an assistor that got through and received service.
c The percentage of callers that waited 30 seconds or less before
  speaking to an assistor.
d The percentage of callers that hung up while waiting to speak to an
  assistor.
e The average number of seconds callers waited before speaking to an
  assistor.
f The percentage of calls in which assistors followed all IRS procedures
  for the call type and provided correct answers.
g The percentage of calls in which assistors provided correct answers
  for the call type, discounting procedural errors.
Source: IRS data.

    IRS Officials Attribute Improvements in
    Telephone Service to Several IRS Efforts
    According to IRS officials, several IRS efforts have contributed to 
improvements in telephone performance. For example, IRS implemented a 
strategy to improve tax law accuracy that included hiring and training 
assistors earlier than in past years and putting them on the telephones 
in December to help hone their skills before the filing season began. 
IRS also required assistors to be certified that they successfully 
completed necessary training and could accurately answer calls in their 
assigned topics and used its computer-based call routing system to help 
ensure that assistors answered calls only in those topics for which 
they had been certified.
    Some officials opined that improvements in accessibility may be 
linked to IRS' efforts to establish new performance measures and goals 
for the call sites this year. For example, each site has a goal for the 
total number of calls its assistors are to answer in a fiscal year. IRS 
officials say the new measures have led to improved performance by 
giving the call sites a clearer understanding of what they are expected 
to achieve and how their performance helps IRS achieve its goals. IRS 
executives in the Wage and Investment and Small Business/Self-Employed 
divisions said that they believe that IRS has been successful in 
getting employees at all levels of the telephone service organizations 
to understand and accept the measures and contribute to achieving the 
goals.
    IRS officials cited several other service improvement efforts as 
potentially boosting performance, including initiatives to bring more 
highly skilled employees on board, increased specialization at the 
assistor and call site levels, and reduced hours of service to increase 
the number of assistors available to answer phone calls during the 
hours when most taxpayers call IRS. We will monitor these and other 
factors that may have affected IRS' telephone service as we continue to 
assess the 2002 filing season.
    IRS' Performance Measures Provide Useful Information on
    Some Aspects of Its Telephone Service but Not on Others
    Although IRS' telephone performance measures provide useful 
information on some aspects of service to taxpayers, the measures miss 
other aspects. For example:

     LNone of the measures currently reflect how many callers 
hung up while listening to the menu they hear when calling IRS--
although IRS has that data. For example, as of March 16, 2002, 
according to IRS data, over 7.2 million callers had hung up when 
listening to the menu this filing season--almost three times greater 
than the number that hung up last year. IRS officials said it is 
unclear why more taxpayers were hanging up. However, when IRS 
streamlined the menu in mid-February, it noted a decline in the hang-up 
rate, which may indicate that taxpayers were frustrated or confused by 
the menu.
     LAlthough IRS assists many callers through automated 
services--almost 18.2 million calls were answered by automation on the 
three main assistance lines and the TeleTax line as of March 2, 2002--
IRS' measures only deal with the service provided by assistors.\16\ IRS 
discontinued measuring the level of service provided through automation 
because this year's data are not comparable to 2001.\17\
---------------------------------------------------------------------------
    \16\ TeleTax provides automated account information and recorded 
information on about 150 tax topics.
    \17\ At the beginning of the 2002 filing season, IRS made changes 
to the TeleTax system that allowed IRS to count abandoned calls, which, 
as of March 2, 2002, were about 31 percent of total TeleTax calls. 
Before the 2002 filing season, because IRS could not count abandoned 
calls, it assumed all calls into TeleTax were served.
---------------------------------------------------------------------------
     LContrary to what its name implies, the CSR level of 
service measure does not reflect only those calls handled by assistors. 
Some calls handled through automation are counted as having been 
answered in computing this measure.\18\ Because it includes calls 
answered through automation, the CSR level of service measure may be 
overestimating the rate at which assistors are responding to taxpayers.
---------------------------------------------------------------------------
    \18\ There were about 780,000 of these calls during the 2001 filing 
season.

    Because we recognize that it is important to limit the number of 
performance measures to the vital few, we are not recommending that IRS 
take any action at this time with respect to the matters discussed 
above. At your request, Mr. Chairman, we are reviewing IRS' filing 
season performance measures, including its telephone measures, and plan 
to issue a report later this year on our results.
IRS Is Measuring Tax Law Accuracy at Its Taxpayer Assistance Centers;
Implementation of Two Other Accuracy Measures Has Been Delayed
    Taxpayers who visit any one of IRS' 400 plus Taxpayer Assistance 
Centers (TAC) can make payments, obtain tax forms and publications, get 
answers to tax law questions, and get help resolving tax account issues 
and preparing tax returns. In the past, IRS has used its employees to 
measure the accuracy of tax law assistance provided by its TACs. In 
fiscal year 2002, IRS began using contract reviewers in lieu of its 
employees. Although the accuracy rate reported through mid-March 2002 
is encouragingly high, the use of different measurement methodologies 
precludes valid comparison to the low accuracy rates reported by IRS 
and the Treasury Inspector General for Tax Administration (TIGTA) in 
2000 and 2001, respectively. IRS had planned to begin measuring the 
accuracy of account and return-preparation assistance in January 2002, 
but those plans have been delayed until June.
    Tax Law Accuracy Rates are Encouraging, but Cannot
    Be Compared to the Low Accuracy Reported in 2000 and 2001
    Contract reviewers, posing as taxpayers, reported making 388 random 
visits to TACs between January 1 and March 15, 2002. During each visit, 
the reviewers asked two tax law questions from the slate of four 
questions that IRS developed for use this year. One question and a 
related scenario was developed from each of four tax law categories 
that most prompted taxpayers to call IRS' toll-free assistance lines in 
fiscal year 2001.\19\ The contract reviewers reported receiving 
accurate responses for 652 of the 776 questions or 84 percent.\20\ 
Although this could indicate that accuracy is improving compared to the 
low accuracy rates reported by IRS in 2000 (24 percent) and TIGTA in 
2001 (51 percent), the use of different accuracy measurement methods in 
the last three filing seasons does not afford a valid basis for 
comparison. Although the results in each of the 3 years were based on 
visits to TACs by persons posing as taxpayers, there were differences 
in such things as the questions the persons asked, the number of weeks 
covered by the reviews, and the number of sites visited and how they 
were selected.
---------------------------------------------------------------------------
    \19\ Field assistance is using the toll-free database to identify 
these categories until such time as it has its own database of the tax 
law categories causing the most questions from TAC customers.
    \20\ We have not assessed these results or the methodology being 
followed by the contract reviewers.
---------------------------------------------------------------------------
    Implementation of Account- and Return-Preparation
    Accuracy Measures Has Been Delayed
    IRS had planned to begin measuring the accuracy of account- and 
return-preparation services provided by TACS in January 2002. However, 
according to field assistance officials, staffing of eight new 
positions for doing these reviews was initially delayed by an oversight 
in the announcement process and then by a hiring freeze. Officials now 
expect to fill the eight positions by June 2002, which, they believe, 
will still allow time to complete enough quality reviews to establish 
meaningful fiscal year 2002 baselines for both measures. According to 
the Director, Field Assistance, the new staff would first complete 
post-reviews of returns prepared during the filing season. Because most 
account assistance occurs after the filing season, they would then 
begin reviewing the accuracy of account assistance provided over the 
remainder of the year.
    Mr. Chairman, that concludes our statement. We would be pleased to 
respond to any questions that you or other Members of the Subcommittee 
may have at this time.
                                 ______
                                 
                               Appendix I
             Increased Demand Related to the Rate Reduction
                Credit Has Likely Affected Accessibility
    As noted earlier, despite some significant improvements in 
telephone service, the customer service representative (CSR) level of 
service as of March 16, 2002, was lower than at the same point in time 
last year. The week-to-week comparisons in Figure 1 show that CSR level 
of service during the first 6 weeks of this filing season was 
significantly better than or about the same as during the first 6 weeks 
of the 2001 filing season but was significantly worse during the next 3 
weeks. In the following 2 weeks, CSR level of service returned to 
levels comparable to last year's performance.
 Figure 1:  CSR Level of Service in the First 11 Weeks of the 2001 and 
                          2002 Filing Seasons
[GRAPHIC] [TIFF OMITTED] T9436A.006

    Note: Beginning the week ending March 2, IRS revised its formula 
for calculating CRS level of service for both 2001 and 2002. Data in 
the graph prior to March 2 are based on the previous formula. Our 
analysis of IRS data showed the change had positive but minimal impact 
on the values, averaging 0.6 percent but never more than 1.89 percent.
    Source: IRS data.

    According to IRS officials, a key factor that may be negatively 
affecting telephone accessibility this year is an increase in the 
demand for assistance, specifically demand related to the rate 
reduction credit. According to IRS officials, demand was lower than 
expected in January 2002, which contributed to an increase in level of 
service. However, as the filing season progressed, demand for 
assistance related to the rate reduction credit increased significantly 
and unexpectedly. IRS officials said that taxpayer access to service 
began declining in early February as more taxpayers called in response 
to publicity about the filing problems related to the rate reduction 
credit and as taxpayers began receiving error notices from IRS. IRS 
data on the amount of demand for telephone assistance generated by the 
rate reduction credit is incomplete, and, therefore, the effect on 
telephone level of service is uncertain.

                                

    Chairman Houghton. Thanks very much. Ms. Kelly.

 STATEMENT OF COLLEEN M. KELLEY, NATIONAL PRESIDENT, NATIONAL 
                    TREASURY EMPLOYEES UNION

    Ms. Kelly. Thank you. Chairman Houghton, Ranking Member 
Coyne and Member Thurman, as the National President of the 
National Treasury Employees Union (NTEU), representing over 
97,000 IRS employees, I very much appreciate having the 
opportunity to appear before you today.
    The past 7 months have been a very trying time for the 
American public. Never before has it been so clear how 
vulnerable our Nation is to a variety of attacks. And never 
before has the need to invest in a highly trained, highly 
skilled, and dedicated Federal workforce been so clear.
    There are nearly 20,000 fewer employees at the IRS today 
than there were just 10 years ago. But as the size of the IRS 
workforce has decreased, the workload has grown and become more 
complex.
    The number of total tax returns filed each year continues 
to increase, and the Tax Code continues to undergo 
congressionally mandated changes. The good news is that the 
American taxpayers are receiving better service from the IRS 
and this past filing season has improved even further on that 
service to taxpayers.
    Unfortunately, it is no coincidence that the examination 
coverage of tax returns has declined during this same period, 
due to decreased staffing and increased workloads. NTEU urges 
your support for increased funding for the IRS in the fiscal 
year 2003 budget so that the workforce has the resources 
necessary to continue to perform current operations while 
simultaneously meeting its modernization goals.
    Unless funding or staffing levels are increased, the IRS 
will not be able to increase tax compliance and enforcement 
activity while at the same time continuing to improve customer 
service to taxpayers.
    In addition to increased staffing and funding for the IRS, 
I would also like to make some additional recommendations that 
will help to improve the efficiency and the effectiveness of 
the IRS.
    As we all know, audit rates and tax compliance are down. 
One reason is lack of staff. Another is Section 1203 of the IRS 
Restructuring and Reform Act which has had a chilling effect on 
the ability of the IRS employees to do their jobs.
    Employees continue to work in fear of Section 1203, 
commonly known as the 10 Deadly Sins. The Administration's 
fiscal year 2003 budget endorsed a package of proposals that 
includes changing the mandatory termination provisions of 
Section 1203 to allow the IRS Commissioner to provide 
appropriate discipline for offenses, up to and including 
termination.
    The President, the Secretary of the Treasury, Commissioner 
Rossotti, the IRS Oversight Board, and NTEU all agree that this 
package of changes will make Section 1203 fairer. NTEU is very 
appreciative of the efforts of this Committee and all of you 
for the modifications that were included in H.R. 3991, the 
Taxpayer Protection and IRS Accountability Act of 2002. Without 
your help, I know that those changes would not have been 
included in H.R. 3991.
    In addition to changes to Section 1203, NTEU urges this 
Subcommittee to reject the Administration's competitive 
sourcing initiative which sets arbitrary quotas for the IRS and 
other Federal agencies to open up thousands of jobs to the 
private sector.
    The Office of Management and Budget has directed every 
agency to open up to the private sector in fiscal year 2002, 5 
percent of the work on the Fair Act inventory list and an 
additional 10 percent in 2003 with a final goal of 50 percent.
    The arbitrary privatization quotas are wrong. The one-size-
fits-all quotas give no consideration whatsoever to unique 
circumstances at agencies like the IRS who are still in the 
middle of a sweeping reorganization that was mandated by 
Congress.
    And this directive is having a negative impact on the 
morale of the IRS workforce. Contracting out government work 
does not in and of itself improve government operations. For 
example, last year we learned that Mellon Bank, a contractor 
hired by the IRS, lost or shredded 70,000 tax returns and 
checks worth $1.2 billion in tax revenues for the government.
    Fortunately, that contract has been terminated by the IRS. 
But we urge this Committee to reject the use of these quotas so 
that the IRS can focus on achieving its mission in the most 
reliable, most cost-effective and efficient manner.
    And finally, recent changes in the estate and gift tax laws 
will lead to fewer estate and gift tax attorneys, because there 
will be fewer returns filed each year. This will mean that most 
of the estate and gift tax attorney jobs at the IRS will be 
eliminated over the next 10 years. All of the attorneys who 
work on estate and gift tax returns at the IRS are in what is 
called excepted service, and as a result, they are not eligible 
to transfer into other competitive service jobs even within the 
IRS, which would be an excellent redeployment of resources 
similar to what Commissioner Rossotti already testified to.
    NTEU urges this Subcommittee to work to retain these 
valuable employees who bring a wealth of experience to the IRS 
by providing them with competitive service status so that they 
are given fair opportunities to transfer to other jobs in the 
Federal Government.
    The bottom line is that IRS employees are committed to 
delivering first class customer service to the taxpayers, and 
they are committed to enforcing the Tax Code in a fair manner. 
But without some important changes, including adequate funding, 
they will continue to have a difficult time meeting these 
goals.
    And I thank you again for the opportunity to be here and 
look forward to any questions you may have.
    [The prepared statement of Ms. Kelly follows:]
 Statement of Colleen M. Kelley, National President, National Treasury 
                            Employees Union
    Chairman Houghton, Ranking Member Coyne, and other distinguished 
Members of this Subcommittee, my name is Colleen Kelley and I am the 
National President of the National Treasury Employees Union. As you 
know, NTEU represents more than 150,000 Federal employees across the 
Federal Government, including the men and women who work at the 
Internal Revenue Service. I want to thank you for giving me the 
opportunity to present testimony on behalf of these dedicated employees 
who play such a vital role in maintaining and strengthening our 
democracy.
    The past seven months have been a very trying time for the American 
public. Never before has it been so clear how vulnerable our nation is 
to such a wide variety of attacks. And never before has the need to 
invest in a highly trained, highly skilled, dedicated Federal workforce 
been so clear. If any American didn't appreciate the national value of 
our Federal employees before the tragic events of September 11th, then 
they sure recognize their work now. Our Nation depends on these 
patriots who work for the Federal Government.
    That is why it is incumbent upon Congress and the Administration to 
ensure that the dedicated employees who perform these vital functions 
for America day in and day out--during times of war and times of 
peace--have the tools and resources they need to do their jobs.
    There are nearly twenty thousand fewer employees at the IRS than 
there were just ten years ago. But as the size of the IRS workforce has 
decreased, the workload has grown and become more complex. For example, 
in 1988, 140 million tax returns were filed; in 2002 the IRS expects to 
receive 231 million returns. In 1999, taxpayers contacted the IRS for 
assistance approximately 117 million times, up from 105 million 
contacts in 1996.
    And in 2001, IRS employees responded to new challenges, first 
expeditiously issuing millions of tax rebate checks and answering 
record numbers of phone calls related to the rebate. Then after the 
tragic events of September 11th, employees worked to provide 
administrative relief to the victims and their families, and worked to 
foster taxpayer giving to charitable organizations.
    Yet, even as the number of total tax returns filed each year 
continues to increase and the tax code continues to undergo sweeping 
changes from Congress, the American taxpayers are receiving better 
service from the IRS. Unfortunately, it is no coincidence that 
examination coverage of tax returns has declined during this period of 
staffing cuts and increased workloads. Unless the downward trend in 
staffing levels is turned around, the IRS will not be able to increase 
tax compliance and enforcement activity, while continuing to deliver 
better services to the taxpayers.
    In addition to increased staffing at the IRS, NTEU would like to 
make some additional recommendations to this Subcommittee on how 
Congress can help improve the efficiency and effectiveness of the IRS 
workforce.
    One issue in particular that has had a chilling effect on the 
ability of IRS employees to do their jobs is Section 1203 of the IRS 
Restructuring and Reform Act. As mentioned earlier, audit rates are 
down. One reason is the lack of staff; another is Section 1203, which I 
believe has also contributed to the declining rates of audits and tax 
compliance. IRS employees continue to work in fear of Section 1203. 
Commonly known as the ``Ten Deadly Sins,'' Section 1203 outlines ten 
infractions for which IRS employees must be fired. One of those 
infractions is the untimely filing of Federal income taxes even when a 
refund is due.
    The Administration's FY 03 budget endorses a package of proposals 
that includes changing the mandatory termination provisions to allow 
the IRS Commissioner to provide appropriate punishment for offenses, 
``up to and including termination.'' In its budget request, the 
Administration noted that an IRS employee who fails to file a refund 
return is subject to termination even though any other taxpayer who 
files a refund return late is not subject to any penalty.
    NTEU is very appreciative of the efforts of Members of this 
Subcommittee in supporting an amendment to include modifications of 
Section 1203 in H.R. 3991, the ``Taxpayer Protection and IRS 
Accountability Act of 2002.'' We are hopeful the full House will vote 
on this legislation soon, and that Members of this Subcommittee will 
continue to press for these changes until they are signed into law.
    The President, the Secretary of the Treasury, the IRS Commissioner, 
the IRS Oversight Board and NTEU all agree that this package of changes 
would make Section 1203 fairer. Violations of any of the ten offenses 
should be taken seriously, but mandatory termination in every instance 
should not be the only disciplinary action available. No other Federal 
or congressional employee is subject to similar mandatory termination 
and fairness demands that IRS employees not be subject to this uniquely 
harsh standard.
    In addition to changes to Section 1203, NTEU also seeks more 
funding for the IRS for staffing and modernization. Unfortunately, the 
Administration's budget for FY 2003 does not provide the IRS with the 
resources necessary for the Service to continue to perform current 
operations, while simultaneously meeting its modernization goals. 
Because the IRS continues to redirect employees from tax compliance 
functions to help with customer service, including answering taxpayers' 
questions, and providing walk-in assistance to taxpayers, the 
Administration's budget comes up far short.
    While the Administration's $10.4 billion request for IRS operations 
may appear to be slightly higher than last year's funding level, the 
funding is essentially flat in ``real'' dollar terms because of a 
budget gimmick suggested by the Administration, that would, for the 
first time, require agencies to pre-fund future retiree health and 
retirement costs from current appropriations. Fortunately, both the 
House and Senate Budget Committees rejected the Administration's 
proposal. Furthermore, the budget ignores the need to hire enough 
additional employees to stop the decline in audits and enforcement 
activities. And the budget fails to provide enough funds for additional 
equipment and better training for the employees.
    Improving customer service, enhancing tax return processing, and 
increasing tax compliance can only happen if the Administration and 
Congress support increased funding for staffing, more advanced 
technology and equipment, and better training. Employees at the IRS 
have responded to the mandates from Congress in the IRS Restructuring 
and Reform Act and are making tremendous progress. However, the current 
IRS workforce can only do so much with its limited resources.
    Next, NTEU urges this Subcommittee to take steps to reject the 
Administration's ``competitive sourcing'' initiative which sets 
arbitrary quotas for the IRS and other agencies to open up thousands of 
Federal employee jobs to the private sector. The Office of Management 
and Budget has directed every department and agency to open up to the 
private sector in fiscal year 2002 the work of five percent of the 
Federal jobs on their FAIR Act inventories and an additional ten 
percent in FY 2003. The Administration will be directing agencies and 
departments to ultimately open up to the private sector fifty percent--
more than 425,000--of these Federal jobs considered commercial in 
nature.
    The arbitrary privatization quotas will significantly disrupt 
operations at the IRS, which, as you know, is in the middle of its 
sweeping reorganization plan. The one-size-fits-all quotas give no 
consideration whatsoever to unique circumstances at the IRS or other 
agencies. And we know this directive is already having a negative 
impact on the morale of the IRS workforce.
    Contracting out government work does not, in and of itself, improve 
government operations. In fact, NTEU believes that in most cases, the 
taxpayers lose when government work is contracted out. For example, 
last year we learned that Mellon Bank, a contractor hired by the IRS, 
lost, shredded, and removed 70,000 taxpayer checks worth $1.2 billion 
in revenues for the government. Fortunately, the IRS eventually 
terminated the contract and is conducting an investigation to determine 
the level of criminal wrongdoing. However, this issue begs the 
question, ``how could we let this fraud go on for so long--70,000 lost 
checks--before we realized there was a problem?'' The answer is quite 
simply that Congress and the Administration have never put in place 
reliable government-wide systems or provided adequate staffing to track 
the work of contractors. There is nowhere near the same level of 
transparency and accountability of the work performed by contractors as 
there is of the work performed by Federal employees.
    NTEU believes the Administration's contracting out quotas will lead 
to more contractor waste at the IRS and other agencies. We urge this 
Subcommittee to reject the use of these arbitrary quotas so that the 
IRS can focus on achieving its mission in the most reliable, cost 
effective, and efficient manner.
    Finally, NTEU urges this Subcommittee to take steps to correct an 
issue affecting estate and gift tax attorneys at the IRS. All of the 
attorneys who work on estate and gift tax returns at the IRS are in the 
``excepted service.'' Regular competitive civil service hiring 
procedures do not cover positions in the excepted service. As a result, 
estate tax attorneys are not eligible to be transferred to other 
competitive service jobs, even within the IRS. So even though they have 
the expertise and qualifications to work on trusts, partnerships, or 
countless other jobs at the IRS, because of their ``excepted service'' 
status, if their jobs are eliminated they will be treated as any other 
outside job seeker.
    Recent changes in the estate and gift tax laws will lead to fewer 
estate and gift tax returns filed each year, which will mean that most 
of the estate and gift tax attorney jobs at the IRS will be eliminated 
over the next ten years. These employees bring a wealth of experience 
to the IRS and are real assets to the Federal Government. NTEU urges 
you to provide competitive status for estate and gift tax attorneys so 
that these valuable employees are given fair opportunities to transfer 
to other jobs in the Federal Government.
    In closing, I have outlined just some of the areas where I believe 
Congress can help to make improvements at the IRS. IRS employees are 
committed to delivering first-class customer service to the taxpayers 
and they are committed to enforcing the tax code in a fair manner. But 
without some changes, they will continue to have a difficult time 
meeting these goals. The full benefits of a more efficient, more 
effective and higher performing IRS workforce will not be realized 
unless Congress and the Administration provide more funding and more 
staffing, and remove many of the barriers to improving morale and 
productivity at the IRS.
    I thank you for holding this important hearing today, and I would 
be happy to answer any questions you may have.

                                

    Chairman Houghton. Thank you very much, Ms. Kelly. I would 
like to ask Mr. Coyne if he would like to inquire.
    Mr. Coyne. Thank you, Mr. Chairman. Mr. White, according to 
IRS statistics, more than 20 percent of callers to the IRS 
received legally incorrect answers to tax questions.
    Why, in your judgment and your agency's judgment, is this 
happening?
    Mr. White. This has been a longstanding problem at IRS, not 
just the accuracy of the answers but also the access to the 
telephones. This year service on the accuracy side has actually 
improved considerably compared to last year. You are correct, 
they still have a long way to go. And I think essentially it is 
a matter of better management across the board. One issue we 
found, for example, is that managers of telephone assistance 
often miss opportunities to evaluate the performance of their 
own operations. And the advantages of doing those kind of 
evaluations mean that they get a better understanding of the 
reasons for performance. And armed with that understanding of 
the reasons for performance, then they would be in a better 
position to take actions to improve performance in the future.
    Mr. Coyne. Ms. Kelly correctly points out that there is 
20,000 fewer employees at the IRS currently. In your agency's 
assessment of the operations of the IRS, is that a contributing 
factor to some of the problems that still exist?
    Mr. White. It is undoubtedly a contributing factor. The 
question is the extent to which it contributes. As I indicated, 
there is an issue of how well you are managing the resources 
you have, as well as the question about the level of the 
resources. And right now, because of those missed opportunities 
to evaluate the reasons for performance, we don't have and IRS 
does not have as good an understanding of the reasons for the 
performance right now as you would like to have.
    Mr. Coyne. I find it quite strange that the EITC has a 
separate allocation for its performance. And you ask why--you 
let us know that we should ask the Commissioner about that or 
ask someone at the IRS about that. What is your idea about why 
that exists? What have you been able to find out about why that 
separate allocation exists?
    Mr. White. Well, I don't know the history. I know it has 
existed for the last 5 years. So this--the continuation that is 
requested now would be the 6th year of this separate 
allocation. And I think it does raise the question, given the 
compliance issues that are there across the board, why for this 
one area of compliance there is a separate appropriation. And 
that is the reason why we felt the Subcommittee might want to 
ask IRS if they see any advantages to the separate 
appropriation.
    Mr. Coyne. Now you don't in your examinations find any good 
reason for it?
    Mr. White. We don't have a position one way or the other on 
it. We did think the Subcommittee might want to ask IRS whether 
they see any advantages to combining all of the compliance 
appropriations into one appropriation.
    Mr. Coyne. Ms. Kelly, are you confident that the taxpayers 
will be protected from any, quote, bad apples at the IRS under 
the Taxpayer Rights Bill scheduled for floor action this week?
    Ms. Kelly. Yes. I am very confident of that. I believe that 
the issues that are on the list to be amended in Section 1203, 
for example, are all issues that identified behavior that was 
unacceptable of IRS employees before the restructuring act was 
ever passed. They were serious offenses, and when they were 
identified, they were dealt with appropriately.
    The problem with Section 1203 is it just allows no 
consideration, if you will, of any alternative discipline 
should the Commissioner deem that to be appropriate. It is an 
automatic proposal to termination. And the mere threat of that 
is what is having the chilling effect on employees. But I do 
believe that it will be, as it was before Section 1203, 
appropriately administered by the IRS.
    Mr. Coyne. Under the current regulations, and since the 
implementation of the restructuring, how many employees have 
been fired under current law?
    Ms. Kelly. There have been very, very few. I could not even 
give you an exact number. I am sure that Commissioner Rossotti 
could because he tracks this very closely. The bottom line is 
there have been very few. That is because of the way in which 
Commissioner Rossotti, as the Commissioner, has implemented the 
language of Section 1203.
    But the problem, if you step back from the termination, is 
the mere threat. And the threat itself has been issued to over 
1,200 employees who were accused of something that proved to 
have no merit to it. But the mere fact that they were under an 
allegation let them know that they would face termination 
unless they could prove the allegation false. That is a 
terribly frightening threat to live under.
    Now, as I said, Commissioner Rossotti has been very level-
handed about this and has gone to great lengths, I think far 
and above what he had to do, which NTEU and IRS employees 
really appreciate.
    But with that language in there, if someone else were the 
Commissioner and chose not to do it, did not make it a priority 
on behalf of employees, it could have a devastating effect.
    Mr. Coyne. I had asked Mr. White earlier about the 
incorrect information that was going out to taxpayers. What do 
you think of this problem? Why do you think that incorrect 
information is being disseminated?
    Ms. Kelly. I think there is not any one easy answer. I 
think it is about staffing. I think it is about training. I 
think it is about the ability of front line managers to 
interact with employees. I think it is about steps the IRS has 
taken successfully, but with more work that needs to be done to 
be able to direct phone calls to employees who are specifically 
trained on an issue.
    That is an ideal situation, if every taxpayer calls with 
one question so they can be routed to an employee who has had 
that specific training. Very few taxpayers call with only one 
question, they often have a variety of questions. And 
sometimes, that could lead to error that employees want to 
correct through more training. They want nothing more than the 
reports to show a high accuracy rate and accountability and 
dependability.
    Mr. Coyne. Thank you.
    Chairman Houghton. Thank you, Mr. Coyne. Mrs. Thurman.
    Mrs. Thurman. Thank you, Mr. Chairman. And thank both of 
you for being here today. Mr. White, were you at all surprised 
by this New York Times article at all, as far as ``Poorly Aimed 
Audits'' is the name of one of them? This was the one that 
talked about--gosh, what did I do with it? I love it when my 
Chairman comes to my rescue.
    Wealthy taxpayers avoiding IRS despite warnings that 
cheating is on the rise. Does that surprise you at all?
    Mr. White. I don't know that I have enough information to 
be surprised or not. One of the fundamental problems with IRS 
in the compliance area, and one they are working very hard to 
address, is the lack of information about compliance. So they 
have a national research program underway right now which, if 
successfully implemented, should give them much better 
compliance information than they have had for a decade and a 
half. And with that kind of information, they will be--they 
will have a much better sense of what is going on with 
different categories of taxpayers and how well they are 
targeting noncompliance in those different groups.
    Mrs. Thurman. Okay. I noticed on your report on page 8, you 
basically talk about, there is an example of missing 
performance goals, involves IRS efforts to address major areas 
of systematic noncompliance. Is there something that we can do 
congressionally or through the bill that may be up today or 
tomorrow that we are not doing that we could have helped in 
bringing these performance goals into reality for the IRS or to 
help us to track what is going on?
    Mr. White. I think the main thing is continued oversight, 
hearings like this, attention to IRS' budget, and demands to 
see linkages between the resources that IRS is requesting for 
particular areas of their operation and the results they expect 
to get. And they are getting better at developing those 
linkages. But they are not there in the compliance and 
collection area yet.
    I gave as an example telephones where they are asking for 
additional money this year, and in the performance plan they 
showed that that should increase accessibility by 5 percent. 
That is the kind of linkage that would be helpful.
    Mrs. Thurman. Okay. So then if we have a hearing next year 
at the same time, we should be asking did you have that 5 
percent or better compliance?
    Mr. White. Yes. Exactly. It is a method that can be used to 
hold them accountable for performance. Up front they tell you 
what performance should be expected given the resources they 
are going to get. And then they can be held accountable for 
that.
    Mrs. Thurman. Ms. Kelly, I notice that you were pleased 
with some of the changes that we have made in the bill for 
tomorrow on the floor. Are there some other suggestions you 
would have given based on--I know you also talk about the 
morale at the department, what is going on because of all of 
the people that are gone. Also, then you hear about not getting 
the right answers to taxpayers, those kinds of things.
    Are there some other things that we should have been doing 
that would have also been beneficial to the taxpayers that 
would have also solved some of these problems?
    Ms. Kelly. You know, in my experience both as the National 
President of NTEU, but also as a former revenue agent--I was a 
revenue agent in Pittsburgh for almost 15 years for the IRS. So 
my answer to that is really not about legislation, but it is 
more about the message that is sent by Congress on the support 
that they provide to the agency. And over the past couple of 
years that has definitely been a positive one. It is an 
important message for taxpayers to hear, to know that not 
because you are going to rubber-stamp everything that the IRS 
does, but that you are supportive of its mission, acknowledge 
it as a respected institution, and are going to provide it with 
the resources it needs to do the tax collection work that our 
country needs to be done.
    So I think that message is important for taxpayers, but it 
is also important for employees. On the heels of the Senate 
hearings back in the late 1990s, employee morale was in a very 
bad place because they felt very unsupported, unvalued in the 
work that they were striving to do every day. So that would be 
the one thing that consistently I know employees watch for, 
whether it is in newspaper articles or in statements made from 
congressional offices, it is very important.
    Mrs. Thurman. Ms. Kelly, also you talked about the 
outsourcing a little bit here. And I am curious. And you said 
that the Mellon Bank actually was--I guess basically terminated 
their contract. Do you know of any things that we--that IRS has 
done to eliminate this kind of a problem if they were 
continuing to do the outsourcing or could we see some more of 
these kinds of things take place? Have you seen any changes?
    Ms. Kelly. I actually have not seen many changes. But I 
would say it is not just about the IRS. The oversight and 
accountability of contracts that are let by the Federal 
Government are something that I believe, and NTEU believes, 
needs much more accountability and oversight. And I think we 
need to focus on this more and more as the Administration's 
initiative to competitively source more work to outside 
contractors is implemented. What will the accountability be, 
what will the oversight be, what will the requirements be of 
the contractor versus what they would be of Federal employees?
    There is legislation pending that addresses all of those 
things. The Truthfulness, Responsibility, and Accountability in 
Contracting (TRAC) Act is one of the things out there that 
would put more accountability in place, and I think would 
support agencies in their interests in overseeing better the 
contractors. I can tell you I am taking a very personal 
interest these days in what kind of oversight does exist in all 
of the Federal agencies. And, in my opinion, it is not where it 
needs to be. And that is in large part because there is not a 
requirement for it through any kind of legislation and I am 
hoping that will change in the future.
    Mrs. Thurman. What do you think the objective of 
outsourcing was? And have we met that objective? And maybe Mr. 
White can tell us also in looking at the IRS.
    Ms. Kelly. I really don't know what the objective was. What 
many will say is that the object is to see if the work can be 
done cheaper by someone other than Federal employees. I believe 
that if Federal employees are provided with the resources, the 
support and the encouragement to do the work, there is no one 
who can do the work of the Federal Government better than 
Federal employees, and them having the opportunity to do that 
is something that has to be there.
    I have heard it is about cost, that is about the only thing 
that I hear. And in some cases that doesn't prove to be the 
case. It might start off cheaper, but very shortly ends up 
being more expensive. Then it is very difficult to bring the 
work back into the Federal Government. You don't hear many 
stories about work coming back in, only going out.
    Mrs. Thurman. Explain this to me. It said, for example, 
last year we learned that Mellon Bank, a contractor has lost, 
shredded and removed 70,000 taxpayer checks worth 1.2 billion 
in revenues for the government. I am not sure I understand what 
that means.
    Ms. Kelly. The contractor was serving as a lockbox 
operation for the IRS and the Finance Management Service, and 
taxpayers were mailing their tax payments in to Mellon Bank. 
And the records as well as the payments--in the numbers that I 
identified in my testimony--disappeared. Employees of the 
contractor were shredding returns, removing them from the work 
place, destroying them. I never interviewed the contractor or 
the employees. But all of the reports talked about employees of 
the contractor doing this, I guess because they either couldn't 
get the work done or didn't choose to do it. So they were just 
disposing of the work.
    Mrs. Thurman. So we could have then lost like $1.2 billion.
    Ms. Kelly. Yes.
    Mrs. Thurman. Mr. White, do you know what that contract was 
worth to the Mellon Bank, what they were paid?
    Mr. White. We have some work that we are doing at the 
request of the Senate Finance Committee looking at the 
management of IRS' lockbox program, the entire program. We have 
started that work, but we are not finished developing our 
findings. So I will be in a better position to answer that 
question when we are done with that work.
    Mrs. Thurman. Mr. Chairman, I would hope that, and Mr. 
White, I will certainly hopefully stay in contact with the 
Senate Finance, but I think that would be very important for us 
to understand and know. Because $1.2 billion is a lot of money, 
in my book. Plus we don't know how much money we were paying 
outside just for this contract in itself. So not only is it the 
$1.2 billion, but it is also what the costs might have been for 
them to have this contract. And so I think that is a very 
important area for us to look at as we move on and listen to 
more of this lockbox area.
    Mr. White. I don't believe that the $1.2 billion was lost. 
I believe that IRS became aware of the situation and is aware 
of the taxpayers that were affected. This occurred last filing 
season and they took some steps to deal with the problem then. 
As I said, I will have more details when we are done with this 
work that we are doing with Senate Finance.
    Mrs. Thurman. We appreciate that. Thank you very much.
    Chairman Houghton. Thanks, Mrs. Thurman.
    I think one of the reasons that I suggested that Mr. 
Rossotti come back is because there are certain things that are 
going on that he has put into place and we would like to get a 
measure of them before he leaves. And I think what you said, 
Mr. White, is true. It is the linkages between the resources 
and the management here. What they are--as a matter of fact, it 
is sort of difficult for this Committee because you got 
different layers. I mean the IRS reports to Treasury and 
obviously they give them the signals. And then on top of that 
you have the IRS Oversight Board which Larry Levitan is the 
head of, and then our board. And we don't want to sort of 
superimpose our own feelings, but we ought to know and we have 
got to be able to have those linkages and understand it very 
clearly before the next person comes on.
    Let me just move off here, because there are two issues. 
One is the internal issue and the other is the external issue. 
Internally, are we dancing as well as we know how? That is what 
we keep talking about. The other thing is--that I am worried 
about is that as you look out over the next hill, you can see 
more and more opportunities to go overseas or to expand the 
international market. That is going to make it very difficult. 
So the question, I think, for you, Mr. White and Ms. Kelly, as 
we look at that, are we structured properly? Because there is 
going to be more emphasis on this than ever, next year, the 
year after, the year after. Or, is this just going to be a 
matter of better electronic equipment or more employees? Tell 
us a little bit about that, the structure versus just more 
resources.
    Mr. White. IRS has reorganized itself to focus on 
individual taxpayer groups. That is one important aspect of 
their overall modernization effort. That part has been 
implemented. There are a number of other aspects to the overall 
modernization effort that are still ongoing. For example, 
information systems modernization is another key aspect. Also, 
performance management and improving performance management are 
key aspects of IRS' structure and how well they are able to 
manage themselves. They have made some progress in that area. 
They still have a lot more to do to develop measures that will 
be useful both internally for management purposes and outside 
for purposes such as this, oversight purposes.
    Chairman Houghton. Would you like to make a comment, Ms. 
Kelly?
    Ms. Kelly. I believe that the structure that is in place 
now with LMSB for the large and mid-size businesses and small 
business and self-employed, those two divisions will need to 
coordinate and communicate very effectively so that what you 
described that is most likely to happen doesn't get lost 
between the divisions and functions. And that is from a 
structure standpoint.
    From an employee standpoint, I believe that employees of 
the IRS are highly trained, accountants by education, and they 
are very interested in looking at more complex issues. They 
would welcome the opportunity, as they are with the 
partnerships that Commissioner Rossotti talked about, and in 
the complex partnership schemes that we are seeing. But I also 
believe that it is going to be about staffing and it is going 
to be about the right training and identification of issues.
    The IRS has recently started looking at a number of 
processes, one of which is the examination process. And they 
have a project that NTEU is working jointly with them on called 
examination reengineering. It is looking at just this. Moving 
employees, their audit skills as well as their training and 
technical tax skills into areas to be able to do the 
partnership schemes that didn't exist 10 years ago, and as they 
will exist in the future with the international schemes you 
described.
    So I think employees are very up to the challenge. I think 
that the structure, as long as the communication continues, 
will support it.
    Chairman Houghton. Okay. Any other questions? Thank you 
very much. It has been very helpful testimony. And we hope to 
see you again. Thank you.
    Now I would like to call the next panel, the last panel. 
There are four panelists. James Dougherty, Chairman, Relations 
with the IRS Committee, American Institute of Certified Public 
Accountants; Mark Ernst, President and Chief Executive Officer 
of H&R Block. Welcome back, Mr. Ernst. Roger Harris, President 
of the Padgett Business Services in Georgia, and Chair of the 
Legislative Affairs Subcommittee of the National Association of 
Enrolled Agents; and William Stevenson, President of the 
National Tax Consultants in Merrick, New York, and Chairman of 
the Federal Taxation Area, Right to Practice Committee, and 
also the National Society of Accountants in Virginia.
    So thank you very much for coming. And maybe, Mr. 
Dougherty, you would like to begin your testimony.

 STATEMENT OF JAMES A. DOUGHERTY, CHAIRMAN, RELATIONS WITH THE 
     IRS COMMITTEE, AMERICAN INSTITUTE OF CERTIFIED PUBLIC 
                          ACCOUNTANTS

    Mr. Dougherty. Thank you.
    Mr. Chairman and Members of the House Ways and Means 
Subcommittee on Oversight, the American Institute of Certified 
Public Accountants (AICPA) thanks you for the opportunity to 
appear here today. I am James Dougherty, Chairman of the AICPA, 
Relations with the IRS Committee. The AICPA is a national 
professional organization that certifies public accountants 
with over 350,000 members.
    Before discussing the feedback we have received about the 
2002 filing season, we would like to urge Congress to support 
full funding of the Internal Revenue Service fiscal year 2003 
budget.
    The AICPA has long advocated funding levels that would 
allow the IRS to efficiently and effectively administer the tax 
laws and collect taxes. Without sufficient funding, taxpayers 
and practitioners will encounter unnecessary problems and 
frustrations. The American taxpaying public is just beginning 
to benefit from the Internal Revenue Service that the Congress 
envisioned when it passed the 1998 IRS restructuring 
legislation.
    While the preliminary results are promising, it is critical 
that Congress move the reform process ahead without delay by 
providing the necessary funding. As regarding the 2002 filing 
season, the IRS has implemented a number of improvements in the 
electronic filing program for 2002 filing season.
    The AICPA especially appreciates nearly all 1040 forms and 
schedules have been made available to electronic filing; two, 
the electronic filers are no longer required to use a paper 
signature document and, three, the electronic payment options 
have been expanded. Similarly, the IRS has expanded electronic 
filing options for business taxpayers over the last year.
    The AICPA looks forward to being a positive partner in the 
electronic filing system and to that end has recently formed a 
task force. We appreciate the many hurdles on the roads to 
achieving the goals established by Congress for the electronic 
filing program. For example, last year's struggles to implement 
the mandated electronic filing of large partnerships ought to 
provide a road map of things to avoid in future 
implementations. The IRS and its constituency can improve 
significantly on future electronic initiatives, but only 
through collaboration with critical stakeholders, collaboration 
that begins early and which is taken seriously by the agency.
    On March 9, 2002, President Bush signed into law the Job 
Creation and Workers Assistance Act. The retroactive provisions 
of the 2002 act have contributed significantly to making this a 
difficult filing season for taxpayers and practitioners. Some 
provisions that have been problematic are, one, an additional 
first-year depreciation deduction equal to 30 percent for 
qualified property purchased after September 10th, 2000; and 
two, an extension in the general net operating loss carry back 
for 2 to 5 years. In order to take advantage of the 
depreciation and Net Operating Loss provision, many taxpayers 
and practitioners found it necessary to file extensions on 
business returns otherwise due on March 15, 2002.
    Also we expect to see more individuals file on extensions 
as well as many taxpayers will have to consider amending 
returns that they already have filed. The IRS has done a 
commendable job in releasing guidance and tax forms on 2002 tax 
law. Nevertheless, we believe Congress should remain cognizant 
of the difficult task it imposed on the Service as a result of 
complex and constant changes in the law, particularly with 
respect to effective dates that do not permit adequate time to 
adjust.
    Advance consultation with the IRS and the practitioners 
could do much to improve the quality and administration of our 
tax laws. The IRS announced a few months that the taxpayers and 
practitioners could obtain employer identification numbers 
(EINs) by calling one toll-free number or they could fax 
requests 24 hours a day, 7 days a week. Similarly, the IRS 
announced last fall to the practitioners hotline program 
changes that were made effective January 2002.
    Since the implementation of these changes were announced, 
two very important administrative programs, taxpayers and 
practitioners have experienced significant busy signals with 
the toll-free numbers involved as taxpayer demand has exceeded 
the IRS capacity to answer these calls.
    While the IRS has announced steps to address these 
problems, we must point out the extreme urgency in fixing the 
EIN and the practitioner hot line programs.
    During the filing season, the AICPA has received numerous 
complaints from certified public accountant (CPA) members who 
have encountered problems in obtaining taxpayer account 
information from the IRS. This appears to be a direct result of 
the IRS difficulties with computer modernization and its 
inability or effect on IRS when trying to access taxpayers 
accounts.
    This a clear contrast to the ability of financial 
institutions to access customer financial transactions 
immediately based on up-to-the-minute data, regarding the 
customers.
    The IRS must continue to foster access to taxpayer account 
information through improvements in telephone services and by 
making secure Internet access available, with the ultimate goal 
of providing one-stop shopping for taxpayers so they can 
resolve the tax accounts in a timely, efficient way.
    The AICPA appreciates this opportunity to offer our 
comments to the Subcommittee and would be happy to discuss any 
of these matters in further detail with you.
    [The prepared statement of Mr. Dougherty follows:]
   Statement of James A. Dougherty, Chairman, Relations with the IRS 
     Committee, American Institute of Certified Public Accountants
    Mr. Chairman and Members of the House Ways and Means Subcommittee 
on Oversight, the American Institute of Certified Public Accountants 
thanks you for the opportunity to appear before you today. I am James 
A. Dougherty, Chair of the AICPA's Relations with the IRS Committee. 
The AICPA is the national, professional organization of certified 
public accountants comprised of more than 350,000 members. Our members 
advise clients on Federal, State, and international tax matters, and 
prepare income and other tax returns for millions of Americans. They 
provide services to individuals, not-for-profit organizations, small 
and medium-sized businesses, as well as America's largest businesses. 
It is from this broad base of experience that we offer our comments 
today on the 2002 tax filing season and the IRS budget.
                             The IRS Budget
    Before discussing the feedback we have received from taxpayers and 
tax practitioners about the 2002 filing season, we would like to urge 
Congress to support full funding of the Internal Revenue Service's 
fiscal year 2003 budget. The AICPA has long advocated funding levels 
which would allow the IRS to efficiently and effectively administer the 
tax laws and collect taxes. Without sufficient funding, taxpayers and 
practitioners will encounter unnecessary problems and frustrations.
    Recently, the National Taxpayer Advocate noted that taxpayers have 
inadequate access to IRS assistance. The AICPA believes any shortfall 
in budgetary support for the IRS will worsen this situation. We are 
also concerned that lack of funds will impede the planned modernization 
of the IRS' equipment and electronic capabilities. Steady progress on 
this front is absolutely essential to sound tax administration.
    The IRS performs an essential, although unpopular, role by 
collecting the revenue needed to operate our government. To continue 
improving collection efficiency, the IRS needs adequate funding. This 
does not eliminate the need to implement and monitor reforms to address 
the problems which exist within the Service. However, budget cuts 
should not be used to penalize the IRS.
    Many AICPA members are tax practitioners. As such, we have seen 
first-hand the problems caused by an IRS that is not responsive to the 
taxpaying public as customers. We have also witnessed the improvements 
initiated by Commissioner Rossotti and the reorganization mandated by 
Congress in the IRS Restructuring and Reform Act of 1998. Reducing the 
IRS appropriation can only delay implementation of the improvements 
Congress expects and we believe the nation's taxpayers will suffer as a 
direct result.
    The AICPA has long advocated that funding for the IRS must be 
sufficient for the Service to efficiently and effectively administer 
the tax laws and collect tax. It is vital to our voluntary compliance 
tax system that the Service have the resources necessary to properly 
enforce the tax laws. When the IRS is, or appears to be, unable or 
unwilling to actively administer and enforce the tax law, serious 
damage to the effectiveness of our tax system results. Therefore, we 
encourage Congress to strongly support the IRS' budget needs. 
Obviously, we expect the Service to identify responsible ways to 
allocate any additional resources it receives over prior years, and 
Congress will through its oversight responsibilities ensure that those 
resources are properly utilized. We also believe Congress should pursue 
multi-year funding (i.e., budgeting for multiple years at once) to 
ensure stable funding for the IRS in the future.
    The American taxpaying public is just beginning to benefit from the 
Internal Revenue Service that Congress envisioned when it passed the 
IRS restructuring legislation. While, the preliminary results are 
promising, it is critical that Congress facilitate moving the reform 
process ahead without delay by providing the necessary funding.
                           2002 FILING SEASON
    In previous testimony before Congress, the AICPA would often report 
that, having heard little from our members by early April, we presumed 
that the filing season was progressing largely without any significant 
problems. Unfortunately, we cannot make the same report for the 2002 
filing season.
    Our comments reflect concerns raised by our member CPA 
practitioners about: (1) electronic filing; (2) the retroactive effect 
of the Job Creation and Worker Assistance Act of 2002; (3) the 
difficulties in obtaining Employer Identification Numbers; (4) the 
revamped practitioner hotline service; (5) problems in accessing 
taxpayer accounts; and (6) difficulties in contacting specific IRS 
personnel.

Electronic Filing

    The IRS has implemented a number of improvements in the electronic 
filing program (ELF) for the 2002 filing season. The AICPA especially 
appreciates that (1) nearly all Form 1040 forms and schedules have been 
made available to electronic filers; (2) electronic filers are no 
longer required to use a paper signature document; and (3) the 
electronic payment options have been expanded. Similarly, the IRS has 
expanded electronic filing options for business taxpayers over the last 
year.
    The AICPA supports electronic tax administration in general, and 
ELF in particular. Although we have yet to hear from our members about 
their experiences with ELF during the current filing season, we hope 
that the ELF improvements will mitigate our members' past concerns 
about electronic filing.
    During previous filing seasons, the AICPA had expressed that the 
Service's inability to accept all forms and all schedules, including 
white paper schedules, elections and related compliance disclosures, 
had been the greatest barrier to widespread use of electronic filing by 
the Institute's members, especially for those practitioners who tend to 
work with the more complex returns. Because effective disclosure is the 
key to the modern reporting system, effective electronic filing of the 
more complex returns could not be expected until all forms and 
schedules could be filed electronically--including ``white paper'' 
schedules, elections, and compliance disclosures.
    Although we support the long-range goal of converting manual 
processes to electronic formats, the AICPA remains frustrated by the 
Service's response to our attempts both to partner with the IRS in 
promoting ELF to our membership and in explaining to the IRS the 
effects of the current systems' limitations on our constituency. As the 
IRS shifts its electronic filing focus from individual returns to 
business returns, the importance of involving, listening to, and 
responding to the various stakeholder groups will become all the more 
critical. Unfortunately, our experience as a stakeholder group in this 
matter has not been positive to date.
    The AICPA looks forward to being a positive partner in the ELF 
system and to that end has recently formed an Electronic Filing Task 
Force. We appreciate the many hurdles on the road to achieving the 
goals established for the electronic filing program by Congress. For 
example, last year's struggles to implement the mandated electronic 
filing of large partnerships ought to provide a ``road map'' of things 
to avoid in future implementations. As we enter the second year of this 
mandate there remain many circumstances in which a related schedule or 
form must be supplied to the IRS on paper--sometimes triggering the 
entire Form 1065 to be filed on paper. The IRS and its constituencies 
can improve significantly on future electronic initiatives, but only if 
there is collaboration that begins early and is truly valued by the 
IRS.

Job Creation and Worker Assistance Act of 2002

    On March 9, 2002, President Bush signed into law the Job Creation 
and Worker Assistance Act of 2002. The retroactive provisions of the 
2002 Act have contributed significantly to making this a difficult 
filing season for taxpayers and practitioners. These measures include 
(1) an additional first-year depreciation deduction equal to 30 percent 
for qualified property purchased after September 10, 2001 and (2) an 
extension in the general net operating loss (``NOL'') carryback period 
from two years to five years for NOLs arising in taxable years ending 
in 2001 and 2002.
    In order to take advantage of the depreciation and NOL (and other) 
provisions, many taxpayers and practitioners found it necessary to file 
for extensions on business returns otherwise due on March 15, 2002. The 
IRS has done a commendable job in releasing guidance and tax forms on 
the 2002 tax law; the agency released a brief summary of the Act on 
March 12 and provided further guidance and tax forms several days after 
the March 15 filing deadline for business returns. Businesses that have 
already filed their returns prior to March 15 might find it necessary 
to amend their tax returns in order to take advantage of the new tax 
incentives. We expect to see more individual returns filed on extension 
as well, reflecting those returns that are affected by these 
retroactive provisions (e.g., those with Schedules C and F could be 
affected). Finally, there will be ongoing issues regarding the 
differences between Federal and State laws in the tax treatment of 
various items or tax benefits--as a result of passage of the 2002 Act.
    While reducing taxes retroactively for taxpayers, the 2002 tax law 
has clearly added additional complexities, compliance costs, and 
administrative burdens for taxpayers and practitioners during the 
current filing season. Congress recognized the complexity of the tax 
administration issue when it included Section 4021 in the IRS 
Restructuring and Reform Act of 1998 (RRA '98), which states ``It is 
the sense of Congress that the Internal Revenue Service should provide 
the Congress with an independent view of tax administration, and that 
during the legislative process, the tax-writing committees of Congress 
should hear from front-line technical experts at the Internal Revenue 
Service with respect to the administrability of pending amendments to 
the Internal Revenue Code of 1986.'' We ask Congress to remain 
cognizant of the difficult task it imposes on the Service, tax 
practitioners and taxpayers when it continues to enact complex and 
constantly changing tax laws, especially with effective dates that do 
not permit adequate time to adjust. Advance consultation with the IRS 
and practitioners could do much to improve the quality and 
administrability of our tax laws.

Employer Identification Numbers

    The IRS has recently announced a number of changes designed to 
improve the processing of requests for new Employer Identification 
Numbers (EINs). These modifications were developed late last year in 
response to concerns raised by the AICPA and other practitioner groups. 
For example, the AICPA detailed the difficulty taxpayers and 
practitioners were having in obtaining EINs to National Taxpayer 
Advocate Nina Olson. We also informed the IRS about problems taxpayers 
were having with submitting Forms SS-4, Application for Employer 
Identification Number, to the Service through the use of the Tele-Tin 
program and by fax.
    In our April 5, 2001 letter to Nina Olson, the AICPA recommended 
that the IRS: (1) increase the number of hours the call-in procedure is 
available each day; (2) create a system for the Service to take 
taxpayer messages to facilitate EIN assignments; (3) acknowledge faxed 
EIN requests; and (4) commit to assigning an EIN within a specified 
time period.
    In response, the IRS announced that beginning on December 1, 2001, 
practitioners can now obtain an EIN on a client's behalf by completing 
the new Third Party Designee section on Form SS-4, thereby eliminating 
the need to obtain a separate Form 2848, Power of Attorney. Also, 
beginning on January 2, 2002, taxpayers and practitioners can call one 
toll-free number or fax EIN requests 24 hours a day, seven days a week.
    However, taxpayer demand has exceeded the IRS' capacity to promptly 
answer calls, resulting in a significant number of busy signals. We 
have also received complaints that taxpayers were not receiving EIN 
numbers in a timely fashion after sending requests in by fax or mail. 
Although the IRS is responding to these filing problems and resulting 
EIN application backlog, we must report that taxpayers and 
practitioners are still reporting problems. Fortunately, the number of 
complaints is reduced compared to the number voiced in January 2002 
when the phone and fax systems were changed.
    The IRS has promptly acknowledged the EIN program's shortcomings 
problems, and we commend this responsiveness. Nevertheless, we urge the 
Service to continue focusing on fixing the remaining problems taxpayers 
and practitioners are experiencing. Because of the importance of the 
EIN program to the overall tax administration process, its effective 
functioning must be of the highest priority.

Practitioner Hotline

    Beginning in January 2002, the IRS modified its toll-free 
practitioner hotline, renamed the ``Practitioner Priority Service.'' 
This new (centralized) program is promoted as the first point of 
assistance for taxpayer account-related issues. Through this revised 
practitioner hotline, the IRS intends to offer practitioners an 
opportunity to obtain fast, accurate, consistent, and comprehensive 
answers from specially trained IRS employees during the hours of 7:30 
a.m. to 5:30 p.m. local time.
    However, the AICPA has received complaints from practitioners who 
consistently experience busy signals when calling the hotline, because 
practitioner demand has exceeded the Service's ability to promptly 
answer calls. The IRS must address the problems that have resulted from 
the centralization of the hotline under the new Practitioner Priority 
Service. A viable and prompt response to hotline calls is imperative 
for fostering successful relationships with a key stakeholder 
constituency and effective tax administration.

Access to Taxpayer Accounts

    During this filing season, the AICPA has received numerous 
complaints from CPA members who have encountered problems in obtaining 
taxpayer account information from the IRS. We believe these complaints 
are an outgrowth of the IRS' difficulties with computer modernization. 
For example, taxpayers and practitioners continue to have problems 
accessing estimated tax payment information. This is in clear contrast 
to the ability of financial institutions to access up-to-the-minute 
customer transaction information. In 2001, the IRS reported that it 
could take the agency up to 16 days to make an adjustment to a 
taxpayer's account due to incompatible internal computer systems--a 
standard that would not be tolerated by any private company or its 
customers.
    Even a modest improvement in accessing taxpayer account information 
would significantly reduce needless correspondence between taxpayers 
and the IRS. The Service must continue to improve its telephone 
services toward the ultimate goal of ``one stop shopping''--enabling 
taxpayers to resolve all their problems with a single IRS 
representative.
    The AICPA also urges the IRS to develop ways for their employees to 
access taxpayer information using secure, privacy-protected Internet 
connections. Taxpayers should similarly be able to view their own tax 
account information using secure Internet connections.

Difficulty in Contacting Specific IRS Employees

    Practitioners encounter problems when attempting to contact 
specific IRS employees, even those contact persons listed on IRS 
notices to taxpayers. The AICPA has learned about numerous Revenue 
Officers (ROs) who will not provide taxpayers with a ``live'' telephone 
number, but instead their messages only provide pager and voice mail 
numbers. Even though the message may state that the RO will call back 
as soon as possible, taxpayers and practitioners are encountering great 
difficulty in actually contacting the specified RO.
    The AICPA recommends that all ``front-line'' IRS employees should 
be required to give their manager's name and telephone number as part 
of their voice mail message. We also strongly recommend that the IRS 
upgrade the quality of its Web site's Interactive Telephone Directory, 
to assist taxpayers and practitioners in identifying the most 
appropriate IRS employee to contact.
                               Conclusion
    The AICPA is encouraged by today's hearing by the House Ways and 
Means Subcommittee on Oversight. We remain strongly committed to 
working closely with Congress to obtain proper funding for the IRS and 
to ensure continued improvements in future tax filing seasons. We are 
optimistic that--with the proper plan and funding levels in place--the 
IRS can achieve an appropriate balance between taxpayer service and 
enforcement. We hope that this hearing will serve as the catalyst to 
spur improvement in IRS service to its taxpaying ``customers'' and in 
the agency's overall operations.
    The AICPA appreciates this opportunity to offer our comments to the 
Subcommittee and would be happy to discuss any of these matters in 
further detail with Subcommittee Members.

                                

    Chairman Houghton. Thank you very much, Mr. Dougherty. Mr. 
Ernst.

   STATEMENT OF MARK A. ERNST, PRESIDENT AND CHIEF EXECUTIVE 
        OFFICER, H&R BLOCK, INC., KANSAS CITY, MISSOURI

    Mr. Ernst. Thank you, Mr. Chairman, Mr. Coyne, Mrs. 
Thurman.
    Thank you for the opportunity to our present our views.
    From our perspective, the good news is the filing season 
has gone smoothly with a few exceptions. Overall the IRS and 
the tax preparation industry are working very well together.
    The IRS is likely to beat this year's target of 46 million 
electronically filed returns. But increasing effort will be 
needed to advance from this year's 35 percent of all filers to 
Congress's target of 80 percent by 2007.
    H&R Block has electronically filed 90 percent of the 12 
million returns we prepared as of March 15th.
    This has been an especially challenging year for the IRS, 
sending millions of advance refund checks, quickly responding 
to families affected by September 11th, and planning for return 
processing contingencies in case of terrorism.
    The IRS, from our perspective, has earned praise for 
simplification of Schedule D, innovative E-filing promotions, 
improved communication with practitioners, and making personal 
identification number (PIN) signature alternatives easier to 
use.
    Commissioner Rossotti deserves a special salute for his 
leadership. He has made a profound contribution for which all 
citizens should be grateful.
    At H&R Block we continue to provide financial as well as 
tax advice to help clients meet their goals and we are 
integrating on-line and off-line tax services. Combining 
services is an increasing trend.
    All in all, the tax season is going well.
    The bad news is that it is not glitch-free. Two new tax 
laws have caused some problems.
    This year's main problem is the rate reduction credit which 
caused confusion and over 3 million errors. The ordering rules 
applicable to the newly refundable child tax credit has also 
caused confusion and IRS errors. The economic stimulus package 
made retroactive tax law changes that required new forms, 
software updates and amended returns. Midstream changes made 
implementation of those very difficult.
    Finally, poor IRS enforcement for the second year in a row 
gave an unfair advantage for tax preparers who file returns 
early without proper W-2s over firms that are in compliance 
with the rules.
    On budget initiatives, I would make three points. First, we 
strongly support full funding for the IRS. One pay-off of 
modernization will be faster refunds for electronic filers.
    Second, on E-Z tax filing, we are pleased that the 
Administration is backing away from an ill-advised proposal to 
build a free IRS on-line tax prep and e-filing system, and 
instead is working toward a constructive partnership with 
private-sector firms.
    I believe that one of the reasons IRS customer satisfaction 
is rising is the effective public-private partnership 
delivering electronic filing. Let's not lose the important 
progress that we have been making.
    Third, on extending the filing deadline to April 30th for 
taxpayers who file and pay electronically, we are concerned 
about losing focus on April 15th, creating compliance 
difficulties, and imposing extra costs on the tax preparation 
industry, all to attract only an estimated 3 percent of tax 
filers in the first year.
    What is really needed to stimulate a massive shift to e-
filing is the incentive of a tax credit available to all tax 
filers, not just those who have a balance due.
    Briefly, on several other issues. On simplification, we 
welcome simplification efforts and submit for the record our 
annual ``top 10'' suggestions.
    On the earned income tax credit, industry hopes to work 
with Congress and the Treasury to improve due diligence and 
simplify the law to reduce noncompliance.
    On the national research audits, we commend the IRS for its 
design of a new compliance measurement system. Better 
information will lead to a fairer tax system.
    On tax preparer regulation, we look forward to commenting 
on coming proposals. Our own training, continuing education and 
code of ethics reflect our longstanding commitment to integrity 
and professionalism and support for a system requiring 
meaningful minimum standards.
    On helping low-income taxpayers, we support well-focused 
government assistance. If expanded services are needed, we hope 
that outsourcing tax preparation and electronic filing to 
private sector tax professionals will be considered.
    On privacy, consideration should be given to updating 30-
year old rules. The standards for tax preparation firms' use of 
client information should be consistent with the 1999 rules 
Congress adopted for financial firms. The IRS should also 
clarify that electronic signatures can be used for online 
consent.
    Finally, on accounting reforms, the vast majority of the 
accounting profession reflects competence and ethical behavior. 
In crafting post-Enron reforms, care should be taken to ensure 
that audit firms can continue to provide tax compliance and 
most tax planning services and that small privately-owned 
business and family firms without large executive staffs should 
continue to be able to use CPAs to advise on a broad range of 
tax and business issues.
    We appreciate the chance to testify, Mr. Chairman, and 
would be happy to respond to questions.
    [The prepared statement of Mr. Ernst follows:]
Statement of Mark A. Ernst, President and Chief Executive Officer, H&R 
                   Block, Inc., Kansas City, Missouri
    Mr. Chairman, Rep. Coyne, and Members of the Subcommittee:
    Thank you for the opportunity to present our views on the tax 
filing season, the IRS budget, and other issues facing our tax system.

Filing Season Success

    The good news is that the filing season has gone smoothly with few 
exceptions. Overall, the IRS and the tax preparation industry are 
working well together.
    With electronic filing up over 14%, the IRS is likely to beat this 
year's target of 46 million e-filed returns, 35% of all filed, compared 
to 40 million, or 31%, last year.
    H&R Block has contributed about one third of those returns, 
electronically filing 90% of the 12 million returns we prepared as of 
March 15.
    This has been an especially challenging tax year for the IRS. It 
sent out over 200 million notices or advance payments in connection 
with last summer's tax cut, it quickly made special allowances for 
taxpayers affected by the September 11 tragedy, and it planned for mail 
and processing contingencies in the face of terrorism risks.
    The IRS deserves praise for improvements to Schedule D (capital 
gains and losses), innovative e-filing promotions, improved 
communication with practitioners, and making PIN signature alternatives 
easier to use.
    Commissioner Rossotti, whose term ends in November, deserves a 
special salute for his leadership. He has made a profound contribution 
for which all citizens should be grateful.
    At H&R Block, we are increasingly providing financial as well as 
tax counsel to our clients, tailoring advice to individual 
circumstances, to help our clients meet their financial goals. We 
expect this trend to continue across the industry. For many clients, 
Tax Day is an opportunity for an annual financial check-up.
    We are also integrating our online and offline capabilities to 
serve taxpayers across the spectrum from ``do it yourselfers'' to those 
needing more personal assistance. Online or software users can get 
questions answered by a tax advisor or have their return professionally 
prepared, reviewed, or transferred to a tax office to meet their 
individual needs.

Filing Season Problems

    The bad news is that the IRS still must administer an overly 
complex tax code and the filing season is not glitch-free.
    Let me highlight eight items, several resulting from two new tax 
laws.
    This year's main problem is the Rate Reduction Credit, where 
multiple terms (``rebates,'' ``advance payments,'' ``refund advances,'' 
``rate reduction credits'') and instructions that confused taxpayers 
and even tax preparers resulted in many rejected e-files and over three 
million errors.
    The ordering rules applicable to the newly refundable Child Tax 
Credit caused confusion. The complex interaction of forms and 
worksheets resulted in IRS errors. Our IRS liaison has been especially 
helpful in the extra casework needed to resolve them.
    Both items came from the ``Economic Growth and Tax Relief 
Reconciliation Act of 2001'' (EGTRRA), signed into law June 7, 2001. It 
also made welcome changes to the Earned Income Tax Credit's tie-breaker 
rules but the changes still require technical corrections and 
clarifications before 2003.
    The economic stimulus package, the ``Job Creation and Worker 
Assistance Act of 2002,'' signed into law March 9, made mid-filing-
season retroactive tax law changes that required new forms, software 
updates, and amended returns. Guidance and technical corrections will 
also be needed.
    In implementing the stimulus act's changes, one service center 
began accepting revised Form 4562s on April 4, and the other centers 
began only yesterday, requiring tax preparers to use two versions of 
the same form at a critical period.
    Some States are not allowing e-filing of returns claiming the 30% 
accelerated depreciation for assets placed into service after September 
10, 2001, and many States have yet to issue rulings regarding the 
changes, adding further complications.
    Although we patiently explain the political realities of writing 
tax law to them, our tax professionals respectfully ask Congress to 
complete new tax laws by mid-September. The IRS and tax practitioners 
need time to create clear forms and instructions, update software, 
train field staff, and prepare properly to minimize problems.
    Another problem this year was the late loading of student loan 
data, which briefly impaired the Debt Indicator, delaying delivery of 
many refunds.
    Finally, poor enforcement, for the second year in a row, against 
tax preparers who file returns early without proper W-2s gave them an 
unfair advantage over firms that comply with the regulations.

IRS Budget and Policy

    On the budget, we share the concern of the IRS Oversight Board that 
the IRS have adequate funds for modernization, one benefit of which 
will be faster refunds for electronic filers. We strongly support full 
funding for that as well as for customer service and compliance 
programs.
    Two initiatives in the budget are of additional interest.

     L``EZ Tax Filing.'' We are pleased that the Administration 
is backing away from an ill-advised proposal to build a ``free'' IRS 
online tax prep and e-filing system and is instead working toward a 
partnership with private-sector firms.
      L  Putting the government in the tax return preparation business 
would be costly, would detract from more important modernization 
priorities, would create a conflict of interest if the tax auditor also 
became the tax preparer, and would raise questions of privacy and 
security.
      L  Industry already provides low-cost, high-quality software and 
online tax preparation programs that are well received by the public. 
It makes available free tax prep and e-filing online to half of 
taxpayers. Absent compelling circumstances, government should not 
compete with the private sector--an established policy followed by the 
last nine Administrations.
      L  OMB's initiative has bruised the trust and cooperative 
partnership that industry and the IRS had forged to increase e-filing. 
We hope that the current Treasury-IRS-industry discussions will put us 
back on a constructive path.
     LTax Filing Deadline. We believe the IRS may be too 
optimistic about the benefits of its proposal to extend the tax filing 
deadline to April 30 for those who file and pay electronically.
      L  Less than one in five taxpayers pays a balance due and only 3% 
of taxpayers are expected to take advantage of the program in its first 
year. If we aim only at the margin, alternative consideration should be 
given to delaying deadlines for payment but not filing. That would 
create a nearly equal incentive without diminishing national focus on 
April 15, without contributing to confusion and compliance 
difficulties, and without imposing extra costs on tax preparers who 
would otherwise reduce staff or close seasonal locations after April 
15.
      L  What is really needed to stimulate a massive shift to e-filing 
is the incentive of a e-filing tax credit available to all filers.

Other Policy Issues

    A brief comment on several other issues:

    1. Simplification. We believe both the study of the Joint Committee 
on Taxation and the Taxpayer Advocate's annual report make excellent 
recommendations. We welcome the prospect of simplification legislation 
such as that Mr. Portman is preparing and the simplification white 
papers expected shortly from the Treasury. Our annual ``top ten'' 
simplification suggestions are attached.
    2. EITC. We are concerned over reports that nearly a third of EITC 
claims did not comply with the rules in 1999. Changes made by EGTRRA 
may create more compliance problems. This requires more cooperation 
between Congress, Treasury, and industry to improve diligence and 
simplify the law.
    3. National Research Program Audits. We commend the IRS for its 
care in designing new compliance measurement audits to capture needed 
information with minimal intrusion. Compliant taxpayers will benefit if 
the program results in better targeting of future enforcement.
    4. Shelters. Abusive tax shelters are a growing problem and we 
recognize the need to deter them through increased disclosure and 
tougher penalties.
    5. Preparer Regulation. The IRS and the Taxpayer Advocate are 
considering new regulation of unlicensed tax preparers. We believe 
need, enforcement of existing laws, costs, budget implications, 
administrative burdens, and alternatives should all be considered. Our 
own training, continuing education requirements, and Code of Business 
Ethics and Conduct reflect our longstanding commitment to integrity and 
professionalism. We look forward to a dialogue on any proposals.
    6. Low-Income Taxpayers. Over 5 million low-income taxpayers 
receive assistance from the IRS and volunteer groups through programs 
we support. We welcome the IRS' efforts to focus aid on those most in 
need at its walk-in sites and this Committee's clarification that IRS-
subsidized tax clinics are intended to resolve post-filing 
controversies, not prepare returns. If expanded services are needed, we 
hope the IRS will consider vouchers to outsource tax prep and e-filing 
to qualified private-sector tax professionals whose training, existing 
e-filing systems, and convenient locations may provide significant 
advantages.
    7. Privacy. For 30 years, advance written client consent has been 
required to use or disclose tax return information. In 1999, Congress 
established different rules to enable financial firms to share customer 
data with affiliates or third parties, subject to customer notice and 
the opportunity to opt out of certain disclosures. Consideration should 
be given to updating rules for tax preparers to make the standards 
consistent. The IRS should also clarify that electronic signatures 
apply to tax preparation software and online transactions, as the 2000 
E-SIGN law intended and as is common in e-commerce.
    8. Accounting Reforms. The vast majority of the accounting 
profession reflects high professionalism, competence, and ethical 
behavior. In the wake of Enron's failure, SEC Chairman Pitt and others 
have proposed many useful reforms. But some proposals may do more harm 
than good. Restrictions on non-audit services should not prohibit an 
audit firm from providing tax compliance or most tax planning services. 
And differences between publicly-traded corporations and smaller, 
privately-owned businesses should be recognized. Lacking extensive 
executive staffs, many entrepreneurs and family firms rely on their CPA 
to provide trusted counsel on a broad range of tax and business issues. 
In such cases, benefits far outweigh risks.
    We appreciate the chance to testify, Mr. Chairman, and would be 
happy to respond to questions.

                                

                   TAX SIMPLIFICATION PROPOSALS: 2002

    Since 1997, H&R Block has annually sent lawmakers, Treasury and IRS 
officials 10 suggestions for Federal tax simplification. The 
recommendations were developed by H&R Block's Training and Research 
Department which serves more than 80,000 H&R Block tax professionals 
who assist over 16 million clients at 9,000 U.S. offices. The 
proposals, distilled from over a million inquiries, are illustrative, 
not comprehensive. They complement those of the AICPA, ABA, and TEI, as 
well as those in annual reports of the IRS' Taxpayer Advocate (the 
latest of which is excellent), and those in the three-volume study by 
the staff of Congress' Joint Committee on Taxation (2001).
    Many of our past recommendations have been adopted. In deference to 
the excellent work of the JCT and the Taxpayer Advocate, our 2002 
proposals support many of their recommendations as well as express 
independent views. Our focus is on problems faced by average taxpayers.
    To help ease tax burdens, we have also testified before Congress on 
simplification and tax reform, proposed legislation to restructure 
payroll taxes, helped the IRS develop simpler forms and clearer 
instructions, led efforts to increase the number of electronically-
filed returns, and suggested improvements in earned income tax credit 
compliance.
    Several points help keep the issue of tax code simplification in 
perspective: \1\
---------------------------------------------------------------------------
    \1\ For earlier H&R Block views on tax code simplification, see 
``Statement of Robert A. Weinberger, Vice President, Government 
Relations, H&R Block, on Tax Code Simplification,'' before the 
Subcommittee on Oversight of the House Committee on Ways & Means, 
including H&R Block's 1998 simplification proposals, June 23, 1998 
[Serial 105-46]; and ``Statement of Kathy T. Burlison, Tax Research and 
Training Associate, H&R Block, on Complexity of the Individual Income 
Tax,'' before the Senate Committee on Finance, April 15, 1999.

     LThe burden of complexity falls most sharply on about 20% 
of taxpayers, the small but significant fraction with higher incomes 
and more complicated financial lives--the self-employed, small business 
owners, those with income from passive activities or in the form of 
capital gains, rent, and pension or annuity disbursements. Low-income 
taxpayers who claim an earned income tax credit (16%) also face unusual 
complexity.
     LFor many other Americans, the tax system is relatively 
simple. Over 80% of tax code provisions relate to business, not 
individual tax returns. Two-thirds of individual filers take a standard 
deduction and do not itemize. About 40% of individual filers are able 
to use simplified, 1-2 page, short forms--1040EZs and 1040As.
     LThe main reasons for complexity arise from defining 
income, rewarding favored activities, and meeting budget needs, not 
from multiple progressive tax brackets.
     LMuch complexity stems from the legislative process which 
involves compromise, pressured last-minute drafting, and tailoring tax 
provisions to fit the funds available, resulting in phase-ins, sunsets, 
eligibility restrictions, etc. Simplification usually loses out to 
competing political needs as many voices press for complicating 
adjustments while there is little constituency for simplification. 
Since 1987, Congress has amended the tax code an average of 1.5 times a 
day.
     LCongress missed an opportunity for major simplifications 
in 2001 by using budget surpluses for large tax rate cuts instead of 
adopting costly simplification proposals, but many low-cost ideas can 
still be implemented.
     LSome complexity makes the tax code fairer by finely 
tuning laws to individual circumstances and avoiding a one-size-fits-
all model. Some complexity comes from using the code to advance non-tax 
social or economic policies, encouraging activities like education, 
retirement savings, child care, home ownership, charity, etc. Some 
complexity helps reduce the taxes we pay.
     LThe IRS is easing complexity administratively by revising 
forms, notices, and instructions.
     LTechnology and tax software dramatically reduce the 
burden of complexity. Half of tax filers use professional tax 
preparers. Over 55% of individual tax returns are prepared using online 
services or software like H&R Block's TaxCut. Reasons include 
convenience, faster refunds, and financial planning, as well as 
complexity. Through the private-sector, nearly 60 million taxpayers are 
eligible for free tax preparation and e-filing online. Through the IRS, 
15 million taxpayers are eligible to file 1040EZ returns free by 
telephone and aid is available at 400 IRS sites. Volunteer groups 
assist another 4 million low-income or elderly taxpayers.

                           EXECUTIVE SUMMARY

Family Issues
 1. LDependent Care Credit. Conform the dependent care credit's 
definition of earned income to EGTRRA's new earned income definition 
for the earned income credit.
 2. LDefinition of Qualifying Child. Unify the definition of qualifying 
child for the dependency exemption, Head of Household filing status, 
and applicable credits.
 3. LAMT. Repeal or reform the alternative minimum tax (AMT).
Education Issues
 4. LEducation Credits. Combine the HOPE and Lifetime Learning credits.
 5. LQualified Education Expenses. Unify multiple definitions of 
qualified education expenses.
 6. LSavings Bond Interest. Simplify the treatment of savings bond 
interest used for higher education. Eliminate the modifications to AGI 
for purposes of calculating the exclusion of U.S. savings bond 
interest.
Investments and Retirement Savings
 7. LLong-term Capital Gains. Replace various capital gain tax rates 
with a capital gain deduction.
 8. LEarly Withdrawal Penalties. Unify penalties for early withdrawals 
from IRAs and employer retirement plans.
 9. LRequired Minimum Distributions. Eliminate the minimum distribution 
requirements for IRAs and employer retirement plans.
10. LDeductible IRA Contributions. Eliminate income phaseouts that 
restrict the number of taxpayers who can make deductible contributions 
to an IRA.

                                

           H&R BLOCK'S 2002 TAX LAW SIMPLIFICATION PROPOSALS
1. Modify Definition of Earned Income for the Child Care Credit
    Proposal: Conform the definition of earned income for purposes of 
calculating the dependent care credit to the definition of earned 
income for the EITC as changed by EGTRRA.

    Current Law: Earned income is a test for the child care credit, 
refundable child tax credit, and the earned income credit. EGTRRA 
changed the definition for the earned income credit (which is also used 
for the refundable child credit), but it did not change the definition 
in the dependent care credit.
    Prior to 2002, the definitions of earned income for the EITC and 
dependent care credit are essentially the same. In EGTRRA, Congress 
addressed the complexity and compliance issues surrounding the add-back 
of nontaxable earned income items for purposes of calculating the 
earned income tax credit. As a result, beginning in 2002, the 
definition of an employee's earned income will include only taxable 
wages.
    The dependent care credit is calculated on the lesser of (1) the 
taxpayer's earned income, or (2) the spouse's earned income for MFJ 
filers, or (3) qualified expenses, limited to $2,400 for one child or 
$4,800 for two children. No credit is allowed for more than two 
dependent children.

    Benefits: The simplification impact of this change is enormous. 
Eliminating the need to consider nontaxable employee compensation for 
purposes of calculating the child tax credit would relieve taxpayers of 
the burden of obtaining information that often is not reported on W-2s. 
Given the low threshold for qualified expenses and the fact that the 
credit is nonrefundable, it is unlikely that the simplified calculation 
will result in much, if any, change in the amount of dependent care 
credit that is claimed.
2. Simplify the Definition of a Qualifying Child
    Proposal: Conform age, relationship, and member of household tests 
for all definitions of qualifying child.

    Current Law: Five commonly used provisions benefit taxpayers with 
children, but each has its own definition of qualifying child:

     LThe dependency exemption.
     LThe child tax credit.
     LThe earned income credit.
     LThe dependent care credit.
     LHead of household filing status.

    The JCT staff recommended a uniform definition of qualifying child 
that would eliminate several tests such as the joint return test and 
the gross income test that appear in only one or two definitions of 
qualifying child. The JCT staff recommends that any child below a 
specified age that has a specified relationship to the taxpayer and 
lives with the taxpayer more than one half of the taxable year is a 
qualifying child for each of these five benefits.

    Benefits: A common definition of qualifying child would greatly 
simplify the application. Some variations may still be required.
3. Repeal or Reform the AMT
    Proposal: Repeal the alternative minimum tax or reform it by 
increasing the exemption amount and simplifying the rules.

    Current Law: The minimum tax--a separate, alternative tax system 
within the income tax code--is a major source of complexity. The 
current version was designed to ensure that ``no taxpayer with 
substantial economic income should be able to avoid all tax liability 
by using exclusions, deductions and credits.'' \2\ The AMT is imposed 
to the extent that a taxpayer's tentative minimum tax exceeds his or 
her regular tax liability. AMT income is the taxpayer's taxable income 
increased by certain preference items and adjusted for certain items 
(such as accelerated depreciation and incentive stock options) that 
have the effect of deferring taxation under the regular tax rules. The 
tentative minimum tax is computed using the amount of alternative 
minimum taxable income in excess of a phased-out exemption amount.
---------------------------------------------------------------------------
    \2\ Joint Committee on Taxation, General Explanation of the Revenue 
Provisions of the Tax Equity and Fiscal Responsibility Act of 1982 
(JCS-38-83), December 31, 1982, at 17-18.
---------------------------------------------------------------------------
    One problem that has caused a great deal of concern in the last 
year is taxation of unrealized gains associated with incentive stock 
options. Although these gains are exactly the kinds of ``substantial 
economic gains'' the current AMT regime is intended to tax, many 
taxpayers suffered unintended hardships because they were unable to 
convert their paper economic gains into realized gains.

    Benefits: Repeal of the individual AMT system would remove a major 
source of complexity but be very costly. Increasing the exemption 
amount, indexing it for inflation, simplifying the rules, and allowing 
personal credits to offset regular tax liability would eliminate some 
of the problems associated with the current system--complex 
calculations, definitional problems, unintended results, and a 
perception that the system is both unfair and irrational--while 
minimizing revenue loss and maintaining the goal of ensuring that 
taxpayers with substantial economic income incur some tax liability. 
Some modification is needed to halt expected sharp increases in the 
number of affected taxpayers over the next decade.
4. Combine the HOPE and Lifetime Learning Credits
    Proposal: Combine the HOPE credit and Lifetime Learning credit into 
one education credit. The new credit would be 20% of qualified 
educational expenses. The maximum credit would be $2,000 per-student 
beginning in 2003. The definition of eligible student would be the 
current definition under the Lifetime Learning credit.

    Current Law: The HOPE Credit is a nonrefundable credit against 
Federal income taxes. The maximum credit amount is $1,500 per-student, 
representing 100% of the first $1,000 of qualified tuition and related 
expenses and 50% of the next $1,000 of qualified expenses. The credit 
is phased-out for modified adjusted gross incomes above $40,000 
($80,000 for joint returns). The credit is available for two taxable 
years, provided that the student has not completed the first two years 
of post-secondary education before the beginning of the second taxable 
year. The student must be enrolled at least half-time in a degree, 
certificate, or other program leading to a recognized educational 
credential at an eligible educational institution.
    The Lifetime Learning credit is also a nonrefundable credit but it 
varies in several ways from the HOPE credit. The Lifetime Learning 
credit is equal to 20% of qualified tuition and related expenses. The 
maximum credit is $1,000 per return ($2,000 for expenses paid after 
Dec. 31, 2002). The educational expenses must be paid to an eligible 
educational institution. The Lifetime Learning credit is not based on a 
student's workload and there is no limit as to the number of years for 
which the credit can be taken. The credit is phased-out over the same 
range as the HOPE credit. The HOPE and Lifetime Learning credits cannot 
be taken in the same year for the same student.

    Benefits: The education credits serve similar purposes, but they 
apply different percentages to different base amounts. The HOPE credit 
can be taken for no more than two years. In addition, the HOPE credit 
is available on a per-student basis and the Lifetime Learning credit on 
a per-return basis. Currently, a student eligible for the HOPE credit 
will always receive a larger credit under the HOPE provisions. However, 
because the HOPE credit may only be claimed for two years, taxpayers 
must often make a choice whether to claim the credit for the first year 
(which often includes only one semester of expenses) or wait and take 
the credit for the following two years. After 2002, when the amount of 
qualifying expenses for the Lifetime Learning credit increases to 
$10,000, many families will need to calculate both credits to determine 
which is more advantageous. Combining the credits will eliminate all of 
these issues. Families with two or more qualifying students could 
benefit substantially.
5. Establish a Single Definition for Qualified Education Expenses
    Proposal: Adopt a uniform definition of qualified higher education 
expenses for all education incentives. The uniform definition would 
include expenses for tuition, books, fees, supplies, and equipment 
required for enrollment or attendance. It would not include expenses 
with respect to any course or other education relating to sports, 
games, or hobbies other than as part of a degree program.

    Current Law: Several provisions of the Internal Revenue Code refer 
to ``higher education expenses.'' These provisions include the HOPE and 
Lifetime Learning credits, Coverdell education savings accounts, 
qualified tuition programs, the exclusion from income for interest on 
EE bonds, the student loan interest deduction, and the exception to the 
early withdrawal penalty for distributions from IRAs. Most of these 
provisions provide a definition of higher education expenses unique to 
that provision.

    Benefits: Establishing a single definition for qualified education 
expenses reduces confusion because taxpayers will no longer have to 
decipher differences in the tax treatment of various expenses. 
Eliminating multiple definitions reduces the possibility of inadvertent 
errors by taxpayers and tax professionals.
6. Simplify Calculation of U.S. Savings Bond Interest Used to Finance 
        Higher Education
    Proposal: Simplify the treatment of savings bond interest used for 
higher education by using adjusted gross income (AGI) rather than 
modified AGI to calculate the exclusion of U.S. savings bond interest.

    Current Law: Interest earned on qualified U.S. Series EE and Series 
I savings bonds issued after 1989 is excludable from gross income if 
the proceeds of the bonds do not exceed qualified higher education 
expenses paid by the taxpayer during the taxable year. The exclusion is 
phased out based on modified adjusted gross income. The phaseout range 
is adjusted annually for inflation. The exclusion is available only 
with respect to savings bonds issued to taxpayers who are at least 24 
years old. A 14-line form is required to determine the income 
limitations. Instructions for the form include a worksheet for 
determining modified adjusted gross income. This calculation involves 
modifying total income (all gross income except taxable interest) and 
modifying adjustments to income (all adjustments except the deduction 
for student loan interest).

    Benefits: The proposal eliminates two worksheets which have little 
effect on the exclusion and streamlines the phaseout calculation.
7. Simplify the Treatment of Capital Gains
    Proposal: In place of multiple capital gains rates, use regular 
income tax rates with a deduction to reduce the effective tax rate on 
capital gains.

    Current Law: In 2001, long-term capital gains may be taxed at a 
maximum rate of 8, 10, 20, 25, or 28% depending on the holding period 
and the type of investment. A taxpayer could have gains on a single 
year's return taxed at several of these rates. In addition, an 18% rate 
will be available in 2006.

    Benefits: Calculation of the tax on capital gains required 36 lines 
on the tax year 2000 Schedule D. As a result of the addition of the 8% 
rate for tax year 2001, the IRS has moved several pieces of the 
calculation to separate worksheets. Thus, the tax calculation on the 
2001 Schedule D requires only 22 lines, but several additional 
worksheets may be required. If the various capital gains rates are 
replaced with a capital gains deduction, Schedule D will be much 
shorter. A capital gains deduction would simplify the foreign tax 
credit calculation.
8. Unify Penalties for Early Retirement Plan Distributions
    Proposal: Unify penalties for early withdrawals from IRAs and 
employer retirement plans.

    Current Law: Taxable distributions from IRAs and from qualified 
retirement plans made before age 59\1/2\ are subject to an additional 
10% tax unless they qualify for an exception. Some exceptions, such as 
distributions on account of death or disability, apply to all tax-
favored retirement plans. However, the exceptions for distributions for 
higher education expenses and for first-time homebuyers apply only to 
IRAs. The exception for distributions made after separation from 
service after age 55 applies only to pension plans.

    Benefits: Eliminates a source of confusion and frustration which 
traps unwary taxpayers. For example, if an individual retires under a 
qualified retirement plan at age 55, distributions from that plan are 
not subject to the early withdrawal penalty. If that individual rolls 
his money into an IRA and then begins taking distributions before age 
59\1/2\, the distributions are subject to an early withdrawal penalty 
(unless another exception applies).
9. Eliminate Minimum Distribution Requirements from Retirement Plans
    Proposal: Eliminate required minimum distributions from IRAs or 
qualified retirement plans during the lifetime of the recipient.

    Current Law: Distributions from IRAs (other than a Roth IRA) must 
begin no later than April 1 of the year following the calendar year in 
which the IRA owner reaches 70\1/2\. Similar rules apply to qualified 
retirement plans, tax-sheltered annuities, and Section 457 plans. A 
penalty of 50% of the required distribution is imposed for failure to 
take a required distribution. IRS is allowed to rebate the penalty in 
certain situations.

    Benefits: The minimum distribution rules are extremely complicated. 
The JCT staff recommended additional changes designed to simplify these 
rules.\3\ We support these recommendations. However, our recommendation 
addresses the most significant trap for the unwary.
---------------------------------------------------------------------------
    \3\ Joint Committee on Taxation, Study of the Overall State of the 
Federal Tax System and Recommendations for Simplification, Pursuant to 
Section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01), 
April 2001, Volume 2, Section III.C.7.(a).
---------------------------------------------------------------------------
10. Eliminate Phaseouts for Deductible IRA Contributions
    Proposal: Remove income limitations for contributions to IRAs.

    Current Law: The allowable deduction for contributions to an IRA is 
not limited by income for unmarried individuals who are not ``active 
participants'' in a qualified retirement plan. The allowable deduction 
for unmarried individuals who are active participants is phased out 
based on modified AGI. Deductions for married individuals who are not 
active participants and whose spouses are not active participants are 
not limited by income. However, if either spouse is an active 
participant, income limitations apply. Different income limitations 
apply depending on filing status and which spouse is an active 
participant.

    Benefits: The rules are extremely complex. The definition of active 
participant can be confusing. Many taxpayers find the rules to be 
arbitrary and unreasonable. Repeal of the income phaseouts should 
improve compliance and reduce taxpayer frustration. We do not have a 
revenue estimate for the proposal.

                                

    Chairman Houghton. Thank you very much, Mr. Ernst. Mr. 
Harris.

  STATEMENT OF ROGER HARRIS, EA, PRESIDENT, PADGETT BUSINESS 
   SERVICES, ATHENS, GEORGIA, AND CHAIR, LEGISLATIVE AFFAIRS 
    SUBCOMMITTEE, NATIONAL ASSOCIATION OF ENROLLED AGENTS, 
                     GAITHERSBURG, MARYLAND

    Mr. Harris. Good afternoon, Mr. Chairman. Thank you for the 
opportunity to be here. On behalf of the National Association 
of Enrolled Agents and its 10,000 members, it is a pleasure to 
be here to talk about the filing season and the upcoming 
budget.
    I guess the good news is for the most part we would say the 
filing season has gone well. A couple of observations we have 
seen is that taxpayers are coming in earlier, and also coming 
in in increasing numbers. I think the people who are coming in 
early probably are a reflection of the economy and their desire 
to get their refunds back sooner.
    I think the fact that our business is growing is a signal 
that complexity is still very much an enemy of the average 
taxpayer, and as long as they are uncomfortable preparing their 
own return they are going to seek out professional help.
    I think the IRS has done a good job in what could have been 
some difficult circumstances this filing season. We have had a 
lot of talk about the rebate checks. I think the IRS did a good 
job in anticipating that taxpayers, when they receive their 
check, would take it and spend it and not remember how much it 
was for, or keep the letter that came with it. Anticipation of 
that the IRS set up a toll-free number that has worked 
extremely well to verify taxpayers rebate amounts.
    Also, we have heard a lot about the stimulus bill and the 
retroactive changes that it created. I think the IRS reacted as 
well to that situation as we could have expected, given the 
impact that it had. I think we will not know for a while what 
the real impact on the filing season will be. I know there is 
going to be a tremendous amount of amended returns that are 
going to have to be filed. I know I talked to one gentleman 
whose office alone is going to have to review 9,000 returns to 
see how many of them have to be amended, that many returns had 
already been filed prior to the passing of the bill. So the 
true cost of that we will find out in the coming months.
    A couple of specific things. Electronic filing----
    Chairman Houghton. Could I interrupt a minute? I may be 
misreading what you are saying. Are you saying that a wave of 
complications are coming in because of the rebates and a 
variety of things this past year which may further complicate 
what the IRS is doing?
    Mr. Harris. Well, I am speaking more specifically of the 
stimulus bill that had some retroactive provisions this year 
that people had already filed, had gone and filed early and now 
are faced with amending to comply with the benefits of the new 
law. Most of the people, obviously, will be better off in terms 
of their taxes, but there will be an offset cost of amending 
returns.
    A couple of other things on electronic filing. Again, I 
think we are seeing an increase in electronic filing. I think 
the system is far from perfect. The self-selected PIN and the 
elimination of the signature has gone a long way to helping the 
system. I would hope that we will continue to look for ways in 
the future to work together, the IRS, practitioners, and 
Congress, to find ways to reach the 80 percent goal.
    As I think the Commissioner said earlier, at the current 
rate of increase, we are not going to make the 80-percent goal. 
So I think we are going to have to look for things that will 
help us in that area. The extension to April 30, and let me 
caution you first, make sure all States are going to honor that 
or this will have no effect, because as a practitioner or 
taxpayer if I have to file by April 15 through my State I am 
not probably going to wait 2 weeks to file my Federal return. 
So I hope there is a recognition we need to get the States on 
board here if we want this to have a significant impact.
    And I think it will have an impact, because it will make a 
practitioner who does not file electronically noncompetitive 
the last 2 weeks of the filing system. So I think it may have a 
surprising effect.
    In reading the other members of my panel's testimony, and 
hearing them, I found the complaints were pretty universal in 
all of our testimonies. We all had concerns about the inability 
to get a Federal ID number, an EIN number, and we had concerns 
about practitioner hotlines. So I think there are things there 
that we all agree have some issue that needs to be dealt with.
    I think the heart and soul of what we hear about is the 
future and the issue of balancing service and compliance, and I 
think what we all want to see is the pendulum stop swinging, 
where we see compliance getting a lot of emphasis 1 year and 
the next year it is service. We want to have a steady pattern 
of going forward where the IRS is doing their two roles, which 
is service and compliance, and I think, obviously, that 
requires an improvement in technology and it requires better 
staff and training. I would hope we could focus more on 
technology and less on people. People are just a very 
inefficient way to go out and build compliance in the Tax Code.
    The interesting discussion I heard today, and I don't have 
a lot of time left but I would certainly be willing to answer 
any questions, in my role as a member of the IRS Advisory 
Council we have looked at this K-1 matching program very 
closely. And while I think there is a tremendous opportunity 
here to catch a lot of unreported income, there is an equal 
opportunity to embarrass the Service if it is not done 
properly, and I would certainly be willing to share my concerns 
in that area at a later date.
    I could not continue my opening comments without joining 
all the Members of this Committee that have praised 
Commissioner Rossotti's 5-year term. I think we have seen 
remarkable change in that 5 years, and I think the Service has 
come a long way. It is unfortunate we cannot convince him to 
stay another 5 years, but I hope we can bring someone in with 
his vision and his understanding of what a good tax 
administration system should look like, because it can be very 
easily turned back around if we do not bring in someone like 
Commissioner Rossotti.
    So I thank you for the opportunity to be here, and I look 
forward to any questions you might have.
    [The prepared statement of Mr. Harris follows:]
 Statement of Roger Harris, EA, President, Padgett Business Services, 
Athens, Georgia, and Chair, Legislative Affairs Subcommittee, National 
         Association of Enrolled Agents, Gaithersburg, Maryland
    Mr. Chairman and Members of the Oversight Subcommittee, I am 
honored to present this testimony on behalf of the National Association 
of Enrolled Agents (NAEA), which is the professional society of 
Enrolled Agents.
    I am Roger Harris, president of Padgett Business Services, a 
nationwide organization providing tax and accounting services to small 
business and self employed taxpayers. I am enrolled to practice before 
the Internal Revenue Service (IRS) and chair NAEA's Legislative Affairs 
Subcommittee. The Association's 10,000 members are tax professionals 
licensed by the U.S. Department of the Treasury to represent taxpayers 
before all administrative levels of the IRS.
    Enrolled Agents were created in 1884 to ensure the ethical and 
professional representation of claims brought to the Treasury 
Department. Members of NAEA ascribe to a Code of Ethics and Rules of 
Professional Conduct and adhere to annual continuing professional 
education standards that exceed IRS requirements for them. Like 
attorneys and certified public accountants, we are governed by Treasury 
Department Circular Number 230 in our practice before the IRS. We are 
the only tax professionals who are tested by the IRS on our knowledge 
of tax law and procedure. Each year we collectively work with millions 
of individual and small business taxpayers. Consequently, Enrolled 
Agents are uniquely positioned to observe and comment on the average 
American taxpayer's experience within our system of tax administration.
    As our members are on the front lines of tax administration, we are 
pleased to share with you the views of these practitioners.
Tax Filing Season Readiness
    It appeared to many of our members that the filing season started 
earlier than usual this year. Under normal circumstances, we don't see 
people until the last week of January. This year, however, taxpayers 
showed up around the middle of January, two weeks earlier than normal.
    We believe that there may be several factors contributing to this 
phenomenon. First, the downturn in the economy left some jobless 
taxpayers coming in early to collect any refunds they were due. 
Secondly, there is widespread use of electronically generated W-2s, so 
taxpayers were getting them earlier from their employers. Finally, we 
are seeing more promotion of the benefits of e-filing by the IRS, as 
well as by commercial return preparer firms, which has had the salutary 
effect of encouraging taxpayers to file early.
    Overall, the tax season has run smoothly. However, we are seeing 
more clients than ever before. Some of this may be attributed to a 
gradual rise in consumer confidence and a resulting willingness to 
spend money on return preparation. Perhaps of greater significance is 
that such willingness is predicated on the fact that more and more 
taxpayers are opting to leave return preparation to the professionals 
because continued tax law complexity makes it difficult for them to 
prepare their tax returns with confidence.
    Certainly the scaled back economic stimulus package signed into law 
on March 9 with retroactive provisions did little to lessen the 
perception that the tax laws appear too complicated for average 
taxpayers to figure out. Many of our members had already filed the 
returns of taxpayers who were affected by these changes. Although the 
retroactive provisions were beneficial and well intended, they will 
result in more amended returns, an additional compliance burden on 
taxpayers and practitioners. Another factor is that taxpayers want to 
be sure they benefit on their tax returns from last year's rebate 
program, and seem uncomfortable in doing it on their own.
    We commend the IRS for its quick response in providing guidance and 
revised tax forms to deal with the stimulus package provisions. We 
believe the IRS acted as quickly and professionally as possible. Its 
actions mitigated the uncertainty facing many taxpayers and 
practitioners.
    The IRS also should be commended for the proactive measure it took 
in providing taxpayers information about their rebates. Anticipating 
that many taxpayers would not keep or perhaps misplace the paperwork 
that accompanied the rebates, the IRS established a toll-free number 
for them to obtain the needed information. Such customer service has 
been very helpful to taxpayers and their practitioners.
The Continued Impact of Modernization
    We now are well into the modernization and reorganization of the 
IRS. The pace of change has picked up considerably. Most of the changes 
instituted were needed and commendable. We believe Congressional 
confidence in the allocation of budget resources to the IRS has been 
warranted. The following are a few examples of good forward progress.

     LThis tax season, for the first time, it is possible to 
file virtually every tax form electronically. This has made it possible 
for many more practitioners to take advantage of the convenience and 
efficiency of this modern method of filing taxes. We hope that it will 
accelerate the Congressional target of 80% of tax returns filed 
electronically by 2007. This goal, of course, cannot be reached without 
additional attractions for practitioners and taxpayers to consider e-
filing their expectation in filing returns.
     LAt the beginning of the tax season, many of our members 
were using or planned to use the PIN or self-selected Personal 
Identification Number with clients whose returns they e-filed. A 
typical, enthusiastic response from NAEA's Member Only message board 
read, ``PINS are neat!'' and then continued to praise the efficiency of 
the system.
      L  Last year when we spoke to you, we noted that as taxpayers and 
tax practitioners became increasingly familiar with the PIN program, it 
would be more acceptable in future filing seasons. This indeed seems to 
be happening. It now is a matter of reaching a suitable comfort level 
with this new approach.
     LCentralization of practitioner hotlines in a practitioner 
priority service system, centralization of the ability to obtain 
Employer Identification Numbers and centralization of the Power of 
Attorney function have been started. These initiatives suggest 
improvements long sought by the practitioner community and have the 
potential of success. For reasons stated later in this statement, there 
are concerns that must be overcome before this can be a reality.
     LThe IRS Web site has been redesigned to make information 
more readily available to taxpayers and practitioners. Web pages 
designed to assist specific groups of taxpayers, such as the small 
business community, have been thoughtfully designed to be user-friendly 
and provide essential information.

    There also have been disappointments.

     LMore than 250 NAEA members have been working with the IRS 
on a pilot Private Secure Messaging System. We were just informed by 
the IRS Electronic Tax Administration that due to a $120 million budget 
crisis, the pilot program will be discontinued after the filing season.
      L  It has long been the desire of practitioners to be able to 
communicate electronically with the IRS. This would be made possible by 
the Private Secure Messaging System. We view this is as an important 
incentive to bring more practitioners into e-filing tax returns. The 
more comfortable practitioners are in dealing with the IRS 
electronically, the more convenient it will be for them to e-file. We 
are, however, optimistic that what was learned in the pilot program 
will be carried forward into a permanent program. However, due to 
budget uncertainties, we cannot be assured that this program will be 
available next filing season. So we wonder, will the lessons learned in 
the pilot program be forgotten, laid on a shelf somewhere to gather 
dust?
     LThe IRS Web site redesign set to launch on January 2 was 
delayed. Unfortunately, the launch came later after the tax season had 
begun in earnest. Practitioners who had bookmarked specific sites found 
their electronic bookmarks useless. NAEA received scores of complaints 
from our members who rely upon the IRS Web site as a tool during their 
daily work with taxpayers.
Strategic Planning Issues
    NAEA believes that strategic planning for fulfilling the IRS 
mission revolves around two important considerations. One is to be 
taxpayer friendly by providing the best customer service to taxpayers 
and practitioners that money can buy. The second concerns compliance. 
Collecting the correct amount of taxes from non-compliant taxpayers 
impacts not only the fairness of our tax system, but its very survival. 
Appropriate funding to make that happen is critical.
    We commend IRS employees who, following the restructuring 
legislation, have experienced a tremendous cultural change and have 
weathered it well. Many consider customer service to be at the 
forefront in this regard. When an IRS employee may not know the answer 
to a question, he or she typically will go the extra mile to assist in 
finding someone who can provide the correct answer. Human resources and 
technology are key to making this a continued reality.
    Change is going to be part of the IRS landscape for many years to 
come. This simply is because the reorganization cannot be accomplished 
at the snap of the fingers, even though we wish that it could.

Customer Service Matters

    For the IRS, there is a major challenge: how to go about 
implementing customer service changes. For example, the practitioner 
priority service (formerly the practitioner hot line)--involving toll-
free lines and other accoutrements--was a long-awaited improvement in 
service. However, the implementation has been anything but smooth.
    Our members report that local practitioner hotlines that were 
supposed to be staffed for several more months during the transition 
are barely functioning because, in part, employees, concerned that they 
will lose their jobs, find others within the organization and depart. 
The rollout across the country was a thoughtful, pragmatic approach, 
but it was timed to coincide with the filing season. This was not a 
good idea. Practitioners don't know where to call--the national number 
or the local number. When a correct number is reached, it was and 
continues to be apparent that assistors are not properly trained. We 
want you to know that this type of transition during high-stress tax 
season is not helpful to the practitioner community.
    NAEA supports an efficient and effective centralization of the 
service for obtaining needed Employer Identification Numbers (EINs). In 
our view, this has not happened. This in part is due to the toll-free 
lines having been overwhelmed from the start.
    By way of background, the EIN system was shutdown from close of 
business December 21 until January 2 in order to accommodate essential 
upgrades. When the site reopened on January 2, callers quickly log 
jammed it. Some practitioners needed EINS to set up trusts or to 
accommodate year-end tax situations. Its unavailability until after 
long delays has not been a good thing.
    Seldom have we received the torrent of complaints that we received 
on the implementation of this particular service. The sustained level 
of demand for EINs surprised even the IRS.
    We believe two things happened. First, the shutdown in late 
December meant that those who desperately needed EINs in order to carry 
out year-end transactions were more desperate by January 2. Second, the 
information was available on the Web site, far beyond the reaches of 
just the practitioner community. Everyone saw it and more people than 
expected acted upon this information.
    While the IRS did train and deploy additional staff as quickly as 
possible, it took several weeks to stabilize the service. Practitioners 
who faxed requests were advised to wait two to three weeks for replies. 
This was difficult for practitioners, faced with urgent deadlines, 
particularly during the stress of tax season.
    On the other hand, we would like to thank IRS staff in the Office 
of Public Liaison and in SB/SE TEC who responded with a quick fix so 
those urgently needing EINs could be accommodated. Basically, they 
recommended that the words ``EIN Applied For'' be printed on the top of 
time-sensitive documents. This common sense approach alleviated a great 
deal of concern for many practitioners faced with absolute deadlines 
and who had no way to obtain an EIN.
    Hand in hand with the implementation of wide-ranging changes goes 
training of employees. As mentioned earlier, we have been impressed 
with the cultural shift toward customer service achieved by the IRS. 
However, the training of personnel to implement IRS initiatives and 
making proper tools available to them are voids in the proper 
functioning of the ``new'' IRS. Many employees have asked our members 
to explain to them what is going on, have not had access to up-to-date 
materials, and have not understood what they are supposed to do. In 
some instances, under the new practitioner priority service, 
practitioners have asked to be forwarded to the Automated Collection 
Service. In numerous cases, customer service representatives do not 
know how to do this.

Compliance Matters

    As indicated above, collecting the correct amount of taxes owed is 
important beyond measure to the fairness of our tax system and perhaps 
its survival. Obviously all customer service initiatives focus on that 
objective. However, there also must be compliance initiatives in place.
    Without compliance initiatives, NAEA is concerned that there will 
be an increased lack of compliance. The fact there have been diminished 
compliance programs in recent years, such as audits, have not gone 
unnoticed by practitioners and taxpayers. It perhaps is beyond 
conjecture that returns are filed without expectation of review and 
enforcement. This leads to ``sloppy'' returns and ones taking 
aggressive positions that cannot be supported. In short, it might be 
said that there no longer is a ``fear'' of being audited.
    It is in the best interests of our tax system to establish 
initiatives in the compliance arena. It is our hope that these 
initiatives would not dwell on compliance measures in which taxpayers 
are directly involved. However, technology must be such to accommodate 
an objective of this nature. In addition, adequate numbers of IRS 
personnel and their training are key to success.
    NAEA acknowledges that establishing indicators and measures are 
important to compliance programs. We await with some trepidation the 
National Research Program (NRP), the successor to the TCMP audits. 
Again, well-trained IRS personnel will make all the difference in 
whether this is an incidental exercise or whether it becomes the focus 
of much anger and frustration. Although reportedly only 2,000 taxpayers 
will be subject to a line-by-line audit, some 30,000 others will find 
themselves in either a correspondence audit or an office audit for some 
portion of their tax returns. While the IRS has made great strides in 
its ability to interact with taxpayers and practitioners, the NRP may 
be a real challenge to such strides.
    We wish to note the forward progress made by the IRS Criminal 
Investigation (CI) unit. Our membership has been concerned about the 
impact of tax cheats on our tax system. The improvements to the CI Web 
site and training examination specialists to look for cases that can be 
referred to CI for appropriate action are positive steps forward in 
compliance efforts. CI's outreach to the public and dealing with IRS 
personnel further the goals of sound tax administration. We encourage 
similar efforts be made with respect to civil tax compliance measures.
The Impact of Tax Complexity on IRS Employees and Taxpayers
    Again, it is clear to NAEA that having sufficient staff who are 
well trained and with the proper tools to perform their jobs are 
integral components of sound tax administration. Further, they are key 
elements to successful implementation of the restructured IRS 
initiatives. NAEA urges your support in making this happen.
    However, we also believe that tax law complexity is an area that 
requires your attention as it affects both taxpayers and IRS employees. 
We respectfully urge you to press for simplification of the tax code.
    As the National Commission on Restructuring the IRS found, there is 
a clear connection between the complexity of the Internal Revenue Code 
and the difficulty of tax law administration and taxpayer frustration. 
Clearly, how the public perceives how well the agency is doing its job 
is tied directly to the level of frustration taxpayers have with the 
constantly changing tax code.
    As frontline practitioners, NAEA believes Congress could provide 
significant relief and make the job of IRS employees more manageable by 
making immediate changes in three areas. First, Congress needs to 
repeal (preferably) or to modify the alternative minimum tax (AMT) for 
individuals. Second, it needs to simplify the rules for qualifying for 
the Earned Income Tax Credit. Third, phase-outs and phase-ins need to 
be standardized.
    These changes would provide significant relief to taxpayers as well 
as allow the IRS to free up resources within the agency for other 
purposes. Without them, customer service and compliance programs are 
more important than ever.
Conclusion
    NAEA believes that the IRS has made good forward progress and, with 
your help, can make even more. It is a tribute to Commissioner 
Rossotti's vision and leadership that the changes to the IRS have come 
about. We are aware that his five-year commitment is drawing to a 
close. If he chooses not to remain at the IRS, we hope his successor 
shares his vision and perpetuates its implementation. Whatever 
Commissioner Rossotti's decision might be, NAEA wishes him well. We 
consider him a person dedicated to taxpayers and the tax system, and a 
friend to tax practitioners.
    Mr. Chairman and Members of the Subcommittee, I am pleased to have 
shared with you the views of NAEA members regarding the filing season 
and the IRS budget. If I may answer your questions or provide you with 
any additional information, I am happy to do so.
    Thank you.

                                

    Chairman Houghton. Thanks, Mr. Harris. Dr. Stevenson.

    STATEMENT OF WILLIAM STEVENSON, PRESIDENT, NATIONAL TAX 
CONSULTANTS, MERRICK, NEW YORK, AND CHAIRMAN, FEDERAL TAXATION 
    AREA, RIGHT TO PRACTICE COMMITTEE, NATIONAL SOCIETY OF 
               ACCOUNTANTS, ALEXANDRIA, VIRGINIA

    Mr. Stevenson. Thank you, Chairman Houghton. My name is 
Bill Stevenson. I represent the National----
    Chairman Houghton. Could I just interrupt a minute? Mr. 
Ernst, I understand you have to go, and that Mr. Weinberger is 
going to sit in in your seat.
    Mr. Ernst. If that is okay with you.
    Chairman Houghton. Do you have full trust and confidence in 
Mr. Weinberger?
    Mr. Ernst. I have mostly full trust and confidence.
    Chairman Houghton. We appreciate very much your being with 
us. You can go at any time. Mr. Weinberger, we are delighted to 
have you with us. Sorry, Mr. Stevenson.
    Mr. Stevenson. I am representing the National Society of 
Accountants and its 30,000 members and affiliates. We are the 
professional preparers of people's taxes, and not only their 
individual taxes but their businesses as well.
    The first time I appeared before you was March 24, 1995. I 
have the videotape. I deviated for a moment, as I am going to 
do now, and ask the Committee to address two issues. One of the 
issues was to figure out some way of providing more oversight 
to the Internal Revenue Service. While my remarks were more 
prophetic than they were influential, history has shown you 
have done this and I think we are a better Nation for it.
    The second issue I asked you to address was the offer-in-
compromise program, and we went a long way in trying to 
straighten it out during the Commissioner's restructuring the 
IRS, and there was some direction in the history of the 
Committee reports. But I must say I was disappointed when I 
found out that some provisions were stripped from your 
legislation that is going to go to the floor tomorrow. I will 
tell you that we are working with the Senate and, hopefully, we 
will get some of these provisions back in and you will have 
time to revisit that issue. It is a very serious matter.
    But let us get to the shocking story of electronic filing. 
Our firm is fully committed to it. My partner and I process 
approximately 800 tax returns one at a time, one person at a 
time, and this year we have fully committed to the program. Ten 
years ago, the National Society of Accountants asked me to take 
a look at the electronic filing program and then, with the IRS' 
invitation as a stakeholder group, to tell them what our 
thoughts were. So I took it very seriously and I produced a 3-
year horizontal case study using a microcosm of 50 tax 
preparing organizations of large and small practitioners, and I 
personally processed several hundred tax returns myself 
electronically.
    I met with the IRS every 6 months for 3 years and I 
presented to them what they needed to do to get the 
practitioner community on board with electronic filing. In 
spite of the fact that they invited us to provide them with 
feedback, not only did they pretty much ignore our remarks but 
they came out with a more restrictive program, and the history 
will show there are 1 or 2 years where electronic filing 
instead of going up went down.
    During that period of time, the professional practitioner 
community took electronic filing off of our radar screen, and 
we kept it off. And that is why the Commissioner said today if 
we file tax returns between April 15 and April 30 we will get 
more of the big returns in. These are the returns that we do. 
And the only reason that we electronically file is not because 
our clients have asked us to do it, it is because we have told 
them we are going to do it.
    So after 9-11, our organization stepped up to the plate and 
told our membership that, look, this is a tough program to get 
started in, but it is an inconvenience of honor and this is 
something we can do to help this Nation defeat some potential 
terrorist problem. So we stepped up to the plate. My firm has 
prepared 99.9 percent of its returns electronically.
    Now I am at the other end of tax season, and I am telling 
you the problem in getting the practitioner community aboard is 
that it takes a lot of extra time. I figured it took my partner 
and me 150 extra hours to produce 600 tax returns in a 9\1/2\ 
week period. The amount of input that individuals like me have 
to put into providing an electronic package is very heavy in 
the first year. And if the IRS wants to sell this program, they 
have to reduce that burden and they have to explain to 
practitioners that this is a new way of doing business. It is 
not easy.
    It is kind of odd that the National Commission to 
Restructure the IRS sent a team of people, including a 
commissioner, to my office to learn about electronic filing. It 
is kind of odd that the Government Accounting Office is sending 
a team of people to learn about electronic filing before they 
present you with their final report. And it is kind of odd that 
the director of practice, who doesn't know anything about 
computerization, has spent a couple of days in my office over 
the last 2 years to learn about the process, but not one person 
from the IRS responsible for writing the program has been there 
to see what the practitioner has to go through with it to 
process this.
    And my time is up.
    [The prepared statement of Mr. Stevenson follows:]
 Statement of William Stevenson, President, National Tax Consultants, 
   Merrick, New York, and Chairman, Federal Taxation Area, Right to 
   Practice Committee, National Society of Accountants, Alexandria, 
                                Virginia
    Mr. Chairman, my name is William Stevenson, D.Ed, EA, CFP. Thank 
you for the opportunity to testify before the Committee today on the 
2002 filing season and the IRS budget request for fiscal year 2003. I 
am the President of National Tax Consultants of Merrick, New York and 
the chairman of the Federal taxation area of the Right to Practice 
Committee of the National Society of Accountants (NSA). It is in my 
capacity as chairman of the NSA tax group that I appear before the 
Committee today.
    The NSA and its affiliated State organizations represent 30,000 
accountants, tax practitioners, business advisors and financial 
planners providing services to over 19 million individuals and small 
business. Most of our members are sole practitioners or partners in 
small to medium sized firms. NSA represents the accountants on Main 
Street, not those on Wall Street. NSA has not received any Federal 
grants or contracts for this fiscal year or for the preceding two 
fiscal years.
    In order to place NSA's remarks in the proper context, we need to 
explain the distinction between the two basic types of tax preparers. 
Members of the first group usually see their walk-in customers once a 
year--to prepare their tax returns. Members of the second group are tax 
practitioners/accountants who provide continuing services to clients 
(return preparation, tax planning and IRS representation, and other 
services). NSA's comments are from the perspective of the second group.
E-FILING
    NSA is committed to electronic filing and has called upon its 
members to become electronic return originators (EROs). In October 
2001, NSA issued a Call to Arms to encourage the membership to embrace 
electronic filing and utilize the Electronic Federal Tax Payment System 
(EFTPS) to pay tax liabilities. NSA's intent was to help reduce the 
risks posed by mail disruptions, lessen the need of the IRS to process 
paper documents and do our part in helping IRS reach its mandated goal 
that 80% of all returns be electronically filed by 2007.
    As the Committee is aware, IRS is lagging behind in reaching this 
goal. NSA believes that part of the reason is that many tax 
practitioners have not jumped on the e-filing bandwagon. Why have more 
tax practitioners not committed to electronic filing? Some will not e-
file unless it is mandated. Some may be near retirement and do not wish 
to invest in new technology or change long-established business 
practices. NSA believes the primary reason is that the IRS has designed 
a system that is not user-friendly and, in fact, increases the workload 
(and cost) for tax practitioners in a business where time literally is 
money.
    Perhaps the experience of my firm can illustrate the problems. My 
firm made the commitment to e-file as many returns as possible this 
filing season. This entailed capital expenditures to upgrade computers 
and communications equipment and required that we re-think our entire 
practice and restructure it to accommodate the requirements of the e-
filing environment. This we understood and accepted as a cost of doing 
business.
    As we began to prepare and file returns electronically, we quickly 
realized that the time needed to prepare a return had dramatically 
increased. For a practice such as mine that will prepare 800 returns 
this season, this translates into 200 to 275 hours of additional work. 
This required time competes with many other immediate time-consuming 
tasks including the preparation of several hundred-business returns and 
handling IRS CP 2000 notices received by clients. One point should be 
made clear. The actual electronic filing of the return is simple and 
quick; it is the extra steps involved in preparing the return and post 
filing activities that consume the extra time.
    First of all, additional data entry is required to prepare the 
return. For example, on a paper return, the preparer transfers the 
dollar amounts from a W-2 and enters it on the appropriate line. On a 
return that will be filed electronically, all the data from the W-2 
including not only data about the taxpayer but also employer data (such 
as name, address and EIN, among other data) must be entered into the 
computer. Multiple W-2s magnify the time factor. Similar activity 
occurs for a form 1099-R. Why the IRS requires this additional 
information has never adequately explained. In effect, IRS has shifted 
its data entry process from the return processing centers to the 
practitioner's office.
    When the preparer signs a paper return, generally the job is 
finished. This is not true with an e-filed return. We transmit the 
return, wait for acceptance by the IRS and the State. Once the 
acceptance is received we print out a letter notifying the client that 
the return has been received and accepted by the taxing authority. If 
for some reason the return is rejected, we have to investigate the 
cause and correct the return immediately and resubmit. In a paper 
environment, most of these problems would not be discovered until after 
the filing season and would be handled when time pressures are much 
less.
    The Treasury is advocating that the filing date for electronic 
returns be extended to April 30 and the Ways and Means Committee 
adopted such a provision in H.R. 3991. This initiative will not solve 
the time problem. Tax returns not completed several days before the 
filing deadline go on extension anyway. This proposal does not extend 
the number of hours in the day early in the filing season. It will 
extend the time for people who already file late. This may be a benefit 
to the commercial preparers and individuals filing their own returns, 
but for the tax practitioner, it is of marginal value.
    The process to become and remain an ERO is not practitioner 
friendly. If one is not an Enrolled Agent, CPA or attorney, the 
application process requires a background check, including 
fingerprinting and a credit check. Preparers of paper returns are not 
subject to these requirements. Another burden imposed by the IRS is a 
program known as the Revenue Protection Strategy. Under this program, 
IRS will make unannounced visits to practitioner's offices. The 
process, which can take several hours, involves interviews with the 
practitioner and staff and a review of documents. Having IRS agents 
appear in the office in the middle of filing season and flashing their 
badges in front of clients is an experience tax practitioners can do 
without.
    Electronic filing is the road of the future. How rough will the 
ride be? Until the IRS does a better job in making the system more 
practitioner-friendly, tax practitioners will be reluctant to accept 
this program. The IRS can do better. Not only must IRS improve its 
outreach to the practitioner community, it must listen and act on the 
advice that NSA and other groups are more than willing to provide.
    If a picture is worth a thousand words, than a hands-on 
demonstration is the equivalent of the Encyclopedia Britannica. I 
invite Members of the Committee and their staff to come to my office in 
New York and experience first-hand a live demonstration of electronic 
filing from the practitioner perspective. I guarantee it shall be an 
eye opening experience.
FEIN DEBACLE
    IRS implemented a new process for issuing Federal employer 
identification numbers (FEIN) in early 2002. This included the transfer 
of workload from ten campuses to three campuses. The result was a 
disaster with taxpayers and practitioners experiencing both difficulty 
in reaching the IRS and lengthy delays in receiving a FEIN. Sometimes 
taxpayers received more than one FEIN.
    Another problem we are experiencing in the field is inconsistent 
handling of the program by IRS staff. In many instances, practitioners 
were advised that a power of attorney (POA) needed to be on file before 
the IRS would speak to the practitioner. This was incorrect. Often, the 
IRS would refuse to fax a FEIN to the practitioner with a valid POA on 
file with IRS. Again, this was incorrect. The end result has been chaos 
and confusion in a program that once ran smoothly.
    In a recent letter to IRS Oversight Board Chairman Larry Levitan, 
Commissioner Rossotti stated that IRS is committed to maintaining a 
level of service at or above 85%. We believe the 85% service level is 
unacceptable. The goal should be 100%. Obtaining a FEIN is a 
fundamental need for many businesses and the IRS should not fail in 
delivery of a basic service to taxpayers entering the system. Imagine 
an 85% service level in obtaining a telephone number. A FEIN is a 
critical identification number and, among other purposes, is needed to 
open a bank account and apply for Subchapter S status. The IRS can and 
should do better. Dealing with this type of problem, particularly 
during filing season, burns up valuable time that could be better spent 
elsewhere.
    On a positive note, the IRS acknowledged they should have had more 
involvement with stakeholders in the planning and development of this 
initiative, and according to the Commissioner, the IRS is ``. . . 
committed to greater stakeholder involvement in the development of 
future initiatives.'' NSA hopes that this new attitude will carry over 
to the next Commissioner.
RETROACTIVE TAX LAW CHANGES DURING FILING SEASON
    Another burden imposed on tax practitioners during filing season 
are tax bills that are enacted during the filing season that have 
provisions retroactive to the preceding tax year. The software 
companies scramble to modify their programs, the IRS scrambles to put 
out guidance and the practitioner is left in the lurch. Should returns 
in progress be filed under previous law and then corrected by filing an 
amended return? Should you delay processing affected returns until 
later in the filing season and hope for guidance? Also, previously 
filed returns must be identified and dealt with.
    The Job Creation and Worker Assistance Act of 2002 (H.R. 3090, PL 
107-147) contain two such provisions: the bonus depreciation provision 
and the net operating loss carry back. We appreciate the concern and 
are grateful that Congress and the Administration acted to provide tax 
relief to workers and small business. Unfortunately the timing of this 
legislation has caused problems in the field and dealing with these 
changes consumes time that must be obtained from another activity. We 
ask that Congress carefully weigh the impact on tax administration when 
considering legislation that contains provisions with effective dates 
that affect the filing season.
IRS BUDGET REQUEST
    NSA supports full funding for the IRS. Simply stated, certain 
initiatives like business systems modernization, taxpayer outreach and 
pre-filing education efforts must receive adequate funding--and receive 
rigorous oversight from this Committee and the IRS Oversight Board as 
part of the deal. We do take exception to the allocation of funds to 
the new National Research Program (NRP) compliance study that will go 
into high gear the fall of 2002.
    The IRS is championing the NRP audits because it says that the 
current audit selection system is yielding too many ``no change'' 
audits. It believes that the new data harvested from the audits of 
50,000 randomly selected taxpayers will enhance the audit selection 
process and result in more productive audits.
    NSA believes that poor audit selection is a result of factors other 
than poor data. The IRS is selecting the nonproductive returns because 
either the wrong people are involved in the selection process or the 
staff has not been properly trained. Furthermore, management pressures 
auditors and Revenue Agents to find quick adjustments and close cases 
as they are measured on cycled time. In other words, there is little or 
no incentive to close cases with adjustments, but a great deal of 
incentive to simply close cases quickly.
    In recent years, the areas of review on a typical taxpayer's return 
have become far fewer than in years past. Many deductions on the 
Schedule A (Itemized Deductions), one of the major battlefields, on 
which the IRS auditors wage their attack, have been either eliminated 
or minimized. For example, we can no longer deduct credit card interest 
or sales taxes. The deduction for medical expenses used to kick in at 
3% of adjusted Gross Income (AGI); now it's 7\1/2\% of AGI for the 
regular tax and 10% for the Alternative Minimum Tax (AMT).
    The deduction for casualty and theft losses must exceed 10% of AGI 
plus $100. Previously, it was 100% of the loss less $100 with no AGI 
limitations. Not only must deductions for job related and investment 
expenses exceed 2% of AGI, but also, if they get too high, the 
alternative minimum tax (AMT) rears its uninvited head and robs the 
taxpayer of all subsequent deductions.
    Mortgage interest is reported to the IRS by banks and mortgage 
companies and matched with Social Security Numbers and has limitations 
that affect the wealthy. The untouched areas on the Schedule A are 
charitable deductions and real estate taxes.
    Losses that are generated from rental property begin to disappear 
for those with AGIs above $100,000 and completely disappear when the 
AGI exceeds $150,000. Furthermore, the AMT robs most taxpayers of 
income levels above $50,000 the benefit of a wide variety of credits: 
low income housing, research and so forth.
    Like mortgage interest, the IRS matches most 1099s and W-2s with 
taxpayers' Social Security Numbers making it almost impossible to ``get 
away with'' omitting income that has been reported by a third party. It 
will take an initiative far greater in scope than the proposed NRP to 
identify those who under report cash income.
    It is no secret that more taxpayers are retaining the services of 
skilled professionals who tenaciously fight to protect the interests of 
their clients. Is it any wonder that more audits are resulting in ``no 
changes?'' Randomly pulling 50,000 tax returns for audit will do very 
little to improve the overall audit program.
    On the other hand, the IRS' ill-advised and ill-timed actions will 
result in frightening 50,000 citizens. The IRS admits that 50% of the 
NRP audits will result in ``no change.'' Many more audit battles will 
percolate up to the Division of Appeals and even the United States Tax 
Court. In prior research programs like the Tax Compliance Measurement 
Program (TCMP), the results from an appeal are not included in the data 
pool, thereby skewing the results.
    It appears that the NRP will affect two major groups of audit 
victims. The first group includes low-income taxpayers who are not 
exposed to the AMT, are minimally exposed to medical and miscellaneous 
expense thresholds and who cannot afford to retain competent 
representation. Naturally, their charitable contributions will come 
under IRS scrutiny.
    The second target group includes small businesses. This area will 
generate many minor changes because many small businesses generally 
cannot afford to maintain efficient bookkeeping systems. In these cases 
the IRS will actually be auditing the work of professional preparers 
who have attempted to keep their clients in compliance by sculpting 
reality from a foundation of canceled checks and oral testimony.
    Based on the Service's current performance, we are convinced that 
the IRS is not in a position to effectively administer its proposed 
National Research Program. Despite assurance of IRS management to the 
contrary, we fear that this program is ripe for abuse by over zealous 
IRS agents. Indeed, at a recent hearing of this Subcommittee, the IRS 
National Taxpayer Advocate in a question and answer session remarked 
that it may be necessary to have a third party monitor these audits to 
protect taxpayers.
    The Service is an agency that is in transition. It has plenty of 
work ahead without deploying its precious assets to an ill-fated and 
ill-timed National Research Program. The taxpayer deserves better. We 
ask the Congress to put an end to this program before it gets off the 
ground.

                                

    Chairman Houghton. Thank you very much, Mr. Stevenson. Mr. 
Coyne.
    Mr. Coyne. Thank you, Mr. Chairman.
    Mr. Harris, the EITC program continues to be one of the 
most common errors that both taxpayers and tax preparer 
professionals make in filing individual tax returns. Seems to 
be still a high percentage.
    Mr. Harris. Yes.
    Mr. Coyne. Can you cite any reasons why you think that is 
the case?
    Mr. Harris. I think probably the best thing that could be 
done, which I guess is the reason we have a problem, is 
clarifying definitions of something like a dependent, that we 
all understand who that qualifying dependent is. I think if you 
asked people on this panel and the IRS, that would go a long 
way, just clarification of a lot of the rules, at least from 
the practitioner side.
    I think perhaps from people who self prepare returns, it is 
just another sign of complexity; that they just really do not 
understand it all.
    Mr. Coyne. Do you see the EITC issue largely one of 
innocent errors or intentional fraud, in your experience?
    Mr. Harris. Certainly from the people that we deal with it 
would be innocent, but I am aware of many cases where there are 
intentional claims made. There is no question that that exists. 
I think any time you make money available there are people who 
will abuse that opportunity.
    Mr. Coyne. But could you put a percentage on it? Is it 10 
percent intentional fraud or 5 percent?
    Mr. Harris. It would simply be a guess, but I would say 10 
percent is intentional, in my opinion.
    Mr. Coyne. And the rest is just through complexity?
    Mr. Harris. Complexity and confusion.
    Mr. Coyne. And definitions, as you point out?
    Mr. Harris. Definitions; right.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mrs. Thurman.
    Mrs. Thurman. Mr. Stevenson, you said you were talking with 
the Senate because there were some things left out of our bill. 
Can you give me what those were?
    Mr. Stevenson. There was a whole section on the offer-in-
compromise program. The House had originally in there items 
that directed the IRS to consider hardship and be very specific 
about what the rules of hardship was, because the IRS 
misinterpreted hardship. Their interpretation of hardship for 
an offer-in-compromise program was that if a taxpayer has all 
the assets to pay for the tax but it is inconvenient for them 
to pay it, that is considered hardship. But if the person was 
poor enough and didn't have the assets to pay for the tax, then 
they could not be considered as a hardship case. It is right on 
their Form 656 as one of the rules for determining an offer-in-
compromise.
    Mrs. Thurman. Maybe to the other three, or to all four, Mr. 
Coyne asked about the EITC, and I think all of us understand 
why that is not getting taken care of, because there are 
winners and losers if you expand it. If you lose, that is a 
problem there. However, I still think if it is causing problems 
out there we ought to be finding out how to fix it. But in 
saying that, and since it seems we have had an experience with 
that, we have heard some of the situations as I have referred 
to in this New York Times article and you all have been sitting 
here, what recommendations would you make to us in this 
matching issue the Commissioner has talked about? How do we 
match this money and make sure we are able to go over to these 
offshore trusts that we are not receiving the benefit from?
    Any one of you.
    Mr. Harris. I will be happy to comment since, as I have 
mentioned, we worked with the Commissioner and the IRS on this 
in some areas. I think you are going about it in the right way, 
trying to match the tax returns of the partnership to the 
individual tax returns. Where the potential for problem is, in 
our experience, and most of us were relating matching to 
something like a W-2 that has a standardized format that goes 
on a single place on a tax return, when you get into this 
matching of K-1's, first of all you have a variety of different 
K-1's where information can go on many, many places on that tax 
return and in some cases correctly not be on the tax return. 
Our caution to the IRS was while you need to catch the 
underreporting of income, the last thing you want to do is send 
out a lot of erroneous notices where you have not been able to 
find that it was correctly reported. And I think you do a lot 
more harm to the agency by sending out millions of notices 
proposing assessments of tax when the return was prepared 
correctly.
    Mrs. Thurman. Mr. Harris, don't you also think that at some 
point, as these kinds of reports come out, that we also hurt 
the IRS on the other end of it; that there are specifically, or 
at least seemingly, instances where the IRS might be targeting 
lower income, middle income people? That is the opposite 
potential you have, too.
    I think there are two sides to that, and I am very 
concerned because I agree I think we have moved much further 
and have really taken some steps to help, but I do worry that 
there will be a feeling on either side. Somebody is not going 
to be happy with this.
    Mr. Harris. I think we need to go forward with matching. I 
think it is part technology, in terms of giving the IRS the 
ability to standardize forms. It is a more encompassing problem 
than I think we think it is. We think it is taking K-1's, 
matching against returns, and we are going to find income, but 
I think we have to look at the bigger picture of form design 
standardization.
    Clearly, I think this tax system is built on a belief that 
there is compliance being done out there, and if we don't shore 
up compliance I think the whole system is at risk.
    Mr. Stevenson. There is another issue, too, and I am sure 
Roger would agree with this. The problem really is training. 
The IRS will run a computer program, such as matching, and then 
automatically send out notices. But there is nobody really 
eyeballing the notices to say do they make sense. What he is 
saying is a lot of them, if anybody really looked at them, they 
would say they do not make sense.
    But let me give you another foreign issue, which I am sure 
no one has even touched. I got a call about a year ago from a 
man from Belgium. He called me up to say, you know, I have set 
up 400 United States corporations in Delaware, and he wanted to 
know if these corporations were required to file a Federal tax 
return and get a Federal ID number. This is one man, 400 
corporations in Delaware.
    I have a contact in Delaware who sets up corporations all 
over the world, and apparently Delaware sets up a corporation 
for a foreign company and there is no matching with the IRS 
that these corporations have been set up. So there could be 
tens of thousands or hundreds of thousands of corporations that 
people set up throughout the world, acting under the rubric of 
an American corporation, with all the rights and privileges, 
but they do not even have an ID number. The guy nearly had a 
heart attack when I told him that, yes, you need an ID number 
and you are out of compliance for not filing these returns.
    And the reason he got caught was because one of his clients 
was using a corporate return and they reported him to the IRS, 
and the IRS said that there was no such corporation. And the 
fraud people from Belgium had contacted him and he was getting 
quite ill about it.
    Mrs. Thurman. So you are saying that we need to be working 
with the States, who do this corporation set-up, so that we 
make sure that we in fact can do what Mr. Harris and others 
have said, be able to match these corporations with the IRS? Is 
that what you are suggesting?
    Mr. Stevenson. I am saying, first of all, Delaware seems to 
be the real problematic area in this, and these are not 
American citizens setting up these corporations. These are 
foreigners setting up American corporations, using our system 
to their benefit, and we are not getting anything out of it.
    Mrs. Thurman. I don't know if either one of you want to 
respond.
    Mr. Weinberger. Just on the earned income tax credit. 
Congress gives the Internal Revenue Service about $147 million 
a year not just for increased compliance with respect to that 
program but also for education and outreach, because a number 
of the taxpayers who are eligible for the credit do not claim 
it, and some who claim it do not claim the full amount that 
they are entitled to. So it is not just a question of 
overpayments; there are in some cases underpayments.
    As you know, it is one of the most effective antipoverty 
programs we have, and Congress has supported it because it 
gives an incentive for people who are poor to continue to work. 
It is also one of the most complex provisions in the Tax Code.
    Several years ago the Treasury Department worked with us to 
develop due diligence procedures where tax practitioners could 
question claimants to make sure they were properly qualified to 
apply for the earned income tax credit. We believe that tax 
professional industry, working with Treasury and Congress, 
should sit down to look at the earned income tax credit and ask 
whether there are simplifications or adjustments that can be 
made.
    Congress recently passed some changes to simplify the tie-
breaker rule that helps determine which member of a family is 
eligible to claim a child, for example. Unfortunately, that 
will require some additional clarification, as is often the 
case when a new law is passed. But we think there may be 
additional simplifications that can be enacted and it is worth 
trying to get that program into a better posture of compliance.
    Mrs. Thurman. I would just say that one of the things in 
one of the articles talked about, and specifically what you 
talk about with regard to the EITC, it says that in the 
Manhattan tax office, and they suggested it is the richest in 
the Nation, there are only 23 auditors that remained on a staff 
that numbered actually 150 just a few years ago. So there 
certainly is a resource issue in trying to bring about 
compliance.
    Let me ask one last question. I think all of you agreed on 
this issue, and that was that in our making changes so close to 
the tax season and not giving an opportunity to put things in 
it to work before tax season comes out. It is an excellent 
comment, because I think we so often do that thinking we are 
just going to hurry this up and everything is going to be 
wonderful.
    Let me ask you this, and maybe it is something we can put 
everybody on notice now. We also know through the stimulus 
package, which was mentioned, that there will be some new 
requirements and some additional tax issues that will be coming 
into effect in 2004, 2005, and 2006. And then all of that goes 
away and we start another whole group of tax issues coming down 
the road, which of course I am very concerned about for a 
couple of reasons other than the complexity, but also the 
revenue side of it.
    Are you at this time being asked or giving any input, or do 
you believe the rules and regulations which you might have to 
work under when these new tax issues come into effect--are we 
seeing any advance notice as to the way this might work, and 
would we have then a better opportunity to use the tax issue as 
it was intended by Congress?
    Mr. Weinberger. Well, with respect to the stimulus package, 
of course that is a classic example, because that made some 
changes that were retroactive and made them right in the middle 
of the tax season. And as hard as the Internal Revenue Service 
works to get forms ready and so on, it is sometimes----
    Mrs. Thurman. But we also will be going into the tax bill. 
I think there is a new IRA, there are some educational issues, 
and there are some things in there. What you are telling me is 
that in fact we know that there is a problem when we push 
things too quickly or they are retroactive or right in the 
middle of the season, like the depreciation issue that you 
mentioned from this stimulus package. Are we seeing at this 
time IRS having the rulemaking authority to start putting rules 
out that would have an effect on these new tax issues that will 
be coming due, or not due but in place in the 2004-2005 
timeframe?
    Mr. Stevenson. Well, first of all, the IRS is really 
historical. They are still auditing 2 years ago or year and a 
half ago. So a large percent of the IRS is looking back. 
Another large percentage is just getting ready for the next 
filing season.
    From our perspective, they are really very--I mean, talk 
about chaos and confusion. They do not have enough people to 
deal with the future. That is really our job. And, frankly, 
from our perspective, we hope some of the things will change, 
because we know you rush some things through. And we really 
love the fact that you are concerned, and you are trying to do 
the best we can. We really understand that.
    We are really struggling with this new thing because we are 
all still suffering and reacting to 9-11. I am from New York, 
as the Chairman is, and we really have not recovered from this 
event, I have to tell you right now. So we know that some 
things that have happened will change. And in the last several 
years, the amount of oversight and the fabulous staff that you 
have in bringing us together and bringing things to your 
attention, we just feel that things will change in the future. 
We cannot do a lot of tax planning for it because historically 
they have changed.
    I don't know if that answers your question. It is hard to 
prepare for things. How do you prepare for the estate tax that 
is going to disappear in 10 years or maybe come back and be 
back to $1 million? We know you have to change that.
    Mrs. Thurman. Can I quote that?
    Mr. Stevenson. You have to change it.
    Mr. Harris. If I could respond a little bit to that. I 
think the average taxpayer doesn't do a lot of tax planning, so 
right now they are not really that concerned about the changes. 
They find out when they have their taxes prepared where they 
won and where they lost.
    The IRS is certainly addressing this, but I don't think 
there is a big demand from the average taxpayer; tell me about 
the changes that are coming this year, next year, the year 
after. Unfortunately, maybe that is an indictment of the 
taxpayers. They have just given up hope on figuring it out. 
They just gather everything together, get their taxes done 
after the first of the year, and they hope they won more than 
they lost in changes. And sometimes they do, sometimes they do 
not.
    Mr. Weinberger. Two aspects of that. One, the Internal 
Revenue Service does consult with tax practitioners as it 
develops new forms and instructions and tries to identify areas 
where the forms and instructions are not as clear as they 
should be. And I am sure as they prepare for some of the 
changes that the Congress has mandated for 2003 and 2004, and 
so on, those forms and schedules will come in due course.
    The other aspect that Mr. Harris was just alluding to, 
however, I think is even more significant, and that is that 
Congress passes many, many programs and tax provisions that are 
beneficial to individuals, and a lot of Americans simply don't 
know they are eligible for them. We find that we are 
increasingly becoming a financial counselor to our clients to 
help them understand provisions that may be available to them 
that they were not aware of.
    So I think there is a financial education component which 
is important, an additional education component with respect to 
tax provisions that Congress intends to apply to Americans that 
they are not fully aware of.
    Mr. Dougherty. In the passing of the act, and, of course, 
everything cannot be perfect in life, so it came along at a 
time and so we are reacting to it. It was a little bit of a 
problem. We will get over that. And I think the Service has 
done a good job. I didn't mean to tell you that I don't think 
the Service has done a good job. I think the Service has done a 
good job. It was late. They have come out afterward and said we 
are going to have to amend some returns and that is going to 
cause some problems.
    But the Service normally does a very good job if the law is 
there. Normally the information does come out. They do consult 
with you. They try to. Sometimes they don't listen to 
everything we tell them, but everybody in life doesn't do that. 
So I think they do do a good job.
    And as for the future, are we doing planning? Obviously, we 
do some planning, too, and our clients do look at this law. We 
do take it serious, it is on the books to see whether it will 
affect them in the future. So, yes, we do have clients that are 
looking at the law and into the future.
    Mrs. Thurman. I appreciate your indulgence, Mr. Chairman. 
So I guess the bottom line is it is just us. The IRS is doing 
fine, if we would just quit changing things in midstream.
    Mr. Dougherty. No, we didn't say that.
    Mr. Weinberger. Well, our tax preparers do----
    Chairman Houghton. Well, now, wait a minute. We cannot go 
on forever here. I appreciate your comments. This is 15 minutes 
and we are usually on a 5-minute basis.
    I want to thank you very much for being here. It has been 
very helpful, and we will be in touch with you again. Thanks so 
much.
    [Whereupon, at 4:21 p.m., the hearing was adjourned.]
    [A submission for the record follows:]

                     Valparaiso University School of Law Tax Clinic
                                     Valparaiso, Indiana 46383-6493
                                                      April 8, 2002

The Honorable Amo Houghton
Chairman
Subcommittee on Oversight
Committee on Ways and Means
1136 Longworth House Office Bldg.

RE:  LStatement to be included in the printed record of the April 9, 
    2002 Subcommittee Hearing on the 2002 Tax Filing Season and the IRS 
    Budget for Fiscal Year 2003.

    Mr. Chairman and Distinguished Members of the Subcommittee,

    Thank you for the opportunity to offer these views concerning the 
2002 fiscal year tax filing season and the IRS budget for fiscal year 
2003. This statement is provided on behalf of the members of the 
Valparaiso University School of Law Tax Clinic. This statement has not 
been approved by the Valparaiso University School of Law and, 
accordingly, should not be construed as representing the policy of the 
University.
    The Valparaiso University School of Law Tax Clinic functions as a 
law office whose primary purpose is to provide practical legal skills 
training for students who are close to completing their law school 
education. The secondary purpose of the clinic is to provide supervised 
legal representation to low-income individuals and groups who otherwise 
would have difficulty in finding affordable representation. 
Specifically, the Tax Clinic represents low-income individuals with 
Federal tax problems both at the administrative level (IRS) and before 
the U.S. Tax Court.
    This clinic has had the opportunity to work with a significant 
number of clients who have had issues with the Earned Income Tax Credit 
(``EITC''). Through our representation of these individuals, we echo 
many of the concerns delineated in the National Taxpayer Advocate's 
Fiscal Year 2001 Annual Report to Congress. On the National Taxpayer 
Advocate's list of the 23 most serious problems, the EITC is a 
prominent component of seven such problems.
    A majority of these problems result from the complexity of the Tax 
Code as it relates to the EITC, as well as from a lack of access to 
free tax assistance, accessibility and affordability of professional 
tax assistance, literacy limitations, language barriers, and even fear 
of contacting the IRS.
    More specifically, taxpayers have a difficult time navigating IRS 
Publication 596, which explains EITC eligibility, and which contains 15 
qualification rules and is more than 50 pages long. As pointed out by 
the National Taxpayer Advocate, Form 886-H, entitled Explanation of 
Items, is extremely difficult for unsophisticated taxpayers to 
understand, and many low-income taxpayers usually cannot afford to take 
the time off from work to collect the required documentation, and often 
do not maintain financial records. Oftentimes, taxpayers are asked to 
provide documents and information already available to IRS employees, 
such as Social Security numbers. The IRS' standards and processing of 
documentation create a heavy burden for the taxpayers least equipped to 
comply with these requirements. As a result, taxpayers find the EITC 
process intimidating and IRS notices difficult to comprehend.
    The National Taxpayer Advocate's Report also indicated that one 
conspicuous EITC-related problem was with the access to and answers 
from the toll-free service lines. Internet assistance via the IRS Web 
site currently does little to alleviate this dilemma. For example, for 
those taxpayers who have the requisite sophistication and access to a 
computer with internet capabilities, a search on the IRS Web site to 
determine what constitutes a ``qualifying child'' will lead the 
taxpayer to 2,224 results. This issue is of special importance to 
taxpayers who qualify for the EITC, who currently have the least access 
to professional tax advice, and rely on government sponsored programs 
and resources to assist them with these questions.
    Based upon the foregoing, and our experiences in providing legal 
representation to low-income individuals with EITC concerns, this 
clinic supports the Administration's IRS budget requests for fiscal 
year 2003 and, in particular, the $154 million requested for the Earned 
Income Tax Credit Compliance Initiative. Although this clinic firmly 
believes that substantive changes to the Tax Code are required to more 
completely address the problems posed by the complexity of the EITC, we 
support the Administration's strong commitment to addressing tax 
problems as they concern low-income taxpayers. The IRS must be given 
sufficient resources to effectively administer initiatives in improving 
the quality employee and volunteer training, clarification of printed 
materials, as well as outreach educational programs.
    In closing, this clinic would like to recognize the efforts and 
beneficial effects of the National Taxpayer Advocate's presence. The 
Office of the National Taxpayer Advocate has been an enormous resource, 
not only in our ability to provide effective legal representation to 
low-income taxpayers, but in our efforts to deepen our understanding of 
complex tax matters as well. We reiterate our support of the 
Administration's commitment to the Earned Income Tax Credit Compliance 
Initiative, and we urge the Members of this Subcommittee and of 
Congress to provide the IRS with the tools necessary to improve its 
relations with low-income taxpayers, thereby increasing participation 
among the less-privileged.
    Thank you again for the opportunity to address this Subcommittee.
            Respectfully,
                                                         Karen Kole
                                          Visiting Professor of Law

Cc:
      The Honorable Charles O. Rosotti
      Commissioner, Internal Revenue Service
      1111 Constitution Ave., NW
      Washington, DC 20244

      The Honorable Nina Olson
      The Office of the National Taxpayer Advocate
      Rm. 3031, C:TA
      Washington, DC 20244

      The Honorable Paul O'Neil
      Secretary of the Treasury
      1500 Pennsylvania Ave., NW
      Washington, DC 20220

      The Honorable Pamela Olson
      Deputy Assistant of U.S. Treasury
      1500 Pennsylvania Ave., NW
      Washington, DC 20220

      David Cay Johnston
      The New York Times
      229 West 43d Street
      New York, NY 10036-3959

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