Testimony

Before Congressional Committees

United States General Accounting Office

GAO

For Release on Delivery

Expected at 10:00 a.m.,

Tuesday, May 14, 2002 TAX ADMINISTRATION

Continued Progress

Modernizing IRS Depends

on Managing Risks

Statement of James R. White, Director, Tax Issues

Randolph C. Hite, Director, Information Technology

 Architecture and Systems Issues

Steven J. Sebastian Acting Director, Financial Management

 Issues

GAO-02-715T
Page 1 GAO-02-715T

Mr. Chairman and Members of the Committees:

We are pleased to be here today as we approach the fourth anniversary of

the Internal Revenue Service (IRS) Restructuring and Reform Act of 1998,

which established Congress’ expectation that IRS modernize to better

meet taxpayer needs. As you requested, our statement gives an overview

of IRS’s current performance and resources and then assesses the

progress that IRS has made modernizing and the risks to continued

progress. Our overview and the rest of our statement are based primarily

on issued reports or ongoing work for the committees holding this

hearing.

Overall, since the mid-1990s IRS has seen increased workload, decreased

staffing, and significant changes in the allocation of resources between

taxpayer assistance programs and its compliance and collection programs.

Any overview of a large agency must condense and summarize a great deal

of information. We selected data, presented in seven figures in the

appendix to this statement, to illustrate some of the key trends at IRS

since the mid-1990s. As our figures show

• Between 1995 and the end of 2001 IRS’s workload, measured by returns

filed, increased by about 10 percent while aggregate staffing declined

by about 14 percent. (See figure 1.)

• Over the same time, there was a significant internal reallocation of

resources with a disproportionate decline in compliance and collection

program staffing to accommodate more emphasis on taxpayer service,

such as telephone assistance, and to information systems operation

and investment. (See figure 2 in comparison with figure 1.)

• Electronic filing of returns increased but not enough to reduce paper

returns sufficiently to free significant processing resources for use

elsewhere. (See figure 3.)

• The reallocation of resources shows signs of beginning to produce

more accurate service for taxpayers, but the compliance and collection

programs have seen large and pervasive declines in performance

indicators such as audit rates, collection cases closed, enforcement

actions such as liens and levies, and raw productivity (measured by

cases closed per unit of staff time without adjusting for possible quality

changes). (See figures 4, 5, 6 and 7.)
Page 2 GAO-02-715T

Mr. Chairman, IRS is at a critical juncture. Commissioner Rossotti, who

has led IRS’s modernization efforts for the past 4-1/2 years, has said that he

will be stepping down in November. That will be about half way through

the 10 years that he estimated would be needed to modernize IRS. During

his tenure, IRS has made important progress at laying the management

foundation for a more modern agency able to respond to taxpayer needs

faster, more accurately, and at lower cost. However, at this time, the

foundation is not complete and neither is the structure to be built on the

foundation – the reengineered processes that would deliver better service

to taxpayers. To continue modernizing, IRS must successfully manage

some significant risks that threaten progress. Areas of risk include IRS’s

compliance and collection programs that have seen large declines, systems

modernization where several large systems are moving into deployment

and performance management where new measures and systems are being

implemented.

The following summarizes our main points regarding the progress IRS has

made and the risks that need to be managed.

• Some of the most important steps that IRS has taken to lay the foundation

for ultimately providing better service to taxpayers and ensuring

compliance with the tax laws are in the areas of organization and

management of performance, systems acquisition and development, and

financial management.

• After much planning, in October 2000, IRS transitioned to a new

organizational structure with four operating divisions focused on

different types of taxpayers.

• About the same time, IRS implemented a new strategic planning,

budgeting, and performance management process, designed to

reconcile competing priorities with the realities of available resources.

Using that process, IRS has determined that almost 2,300 staff positions

could be redirected toward higher-priority needs. In addition, IRS now

has an evaluation system for front line employees that is aligned with

the mission and goals of the agency and is developing a sorely needed

measure of voluntary compliance.

• With respect to systems modernization, IRS has made important

progress in establishing the systems infrastructure, delivering two

systems applications, and establishing the controls and capabilities

needed to effectively acquire and deploy modernized systems.

• Finally, with respect to financial management, IRS has for 2

consecutive years prepared financial statements that received

unqualified opinions.
Page 3 GAO-02-715T

Many of these steps increase IRS’s management capacity. Some are

beginning to deliver better service to taxpayers or more efficient use of

resources.

• To realize the promise of modernization to deliver better service to

taxpayers while ensuring compliance with the tax laws, IRS must finish

building a strong management foundation and must use this foundation to

make the substantive business practice changes that could improve its

efficiency and service to taxpayers. There are risks in several areas that

threaten continued progress.

• One area of risk is IRS’s compliance and collection programs that have

declined, sometimes dramatically, since 1996. Many view these

programs, such as audits to determine whether taxpayers have

accurately reported the amount of taxes they owe and collection

followup with taxpayers who have not paid what is owed, as critical for

maintaining the public’s confidence in our tax system. The

commissioner has emphasized the need to reverse the trends in these

programs.

• Another area of risk is systems acquisition and deployment. Since 1999,

Congress has provided almost $1 billion for investment in IRS’s

business systems. Despite the important progress in building

management capacity, IRS is not where it committed to be in acquiring

infrastructure and business application systems and is not where it

needs to be in implementing management controls and capabilities.

This increases the risk of not delivering promised systems capabilities

on time and within budget. As IRS moves forward, this risk is amplified

because system interdependencies and complexity increase

dramatically during the later phases of system projects.

• Certain aspects of performance management are another risk area. IRS

needs to ensure that it has comparable performance measures over

time and sufficient data to assess performance. IRS needs to routinely

do better evaluations of its programs to determine the factors that

affect performance and identify ways to improve.

• A final risk area is financial management. Although it received an

unqualified audit opinion, IRS has had to assign staff to manually

analyze and correct the data generated by its financial systems. This

approach, which takes months to complete, does not produces timely

information for managing the agency.
Page 4 GAO-02-715T

The following highlights some of the most important steps that IRS has

taken to lay the foundation for ultimately providing better service to

taxpayers and ensuring compliance with the tax laws.

First, during fiscal year 2001, IRS transitioned to a new organizational

structure with four divisions having responsibility for administering tax

law for a set of taxpayers with similar needs. By reorganizing in this

manner, IRS sought to establish clearer lines of responsibility and

accountability for improving service to taxpayers and resolving their

problems. Through such improvements, IRS expected to better enable

taxpayers to comply with the tax laws.

Because many major reengineering efforts were to be led by the new

divisions, it is too early to judge the impact that the reorganization has had

in improving service. The widescale reorganization was accomplished with

no serious disruption of recent filing seasons. The filing season for most

individual taxpayers extends from January 1st to April 15th. It is during

that time when most taxpayers file their returns, call IRS with questions,

and make other contacts with IRS related to filing. To its credit, IRS was

able to reorganize while managing the challenges associated with the

sheer scope of filing season activities, including the year 2000 transition.

To make decisions for fiscal year 2002 and subsequent year operations,

IRS implemented a new strategic planning, budgeting, and performance

management process during fiscal year 2000. The process begins, as

outlined in figure 1, with the operating divisions preparing strategic

assessments that describe significant trends, issues, and problems and

identifies proposals for dealing with them. After receipt and review of the

strategic assessments, the commissioner provides detailed guidance (step

2) to the operating divisions for developing their strategy and program

plans (step 3). These plans are then incorporated (step 4) into an IRS-wide

performance plan (which sets out measurable objectives such as the

number of audits to be done). These plans are, in turn, incorporated into

IRS’s budget justification (which sets out its resource requests to

Congress). The remaining steps (5 and 6) involve allocating resources

across IRS divisions and programs and monitoring division adherence to

the planning and budgeting decisions.

Improved Foundation

for Tax

Administration

New Organizational

Structure

New Budgeting and

Planning System
Page 5 GAO-02-715T

Figure 1: IRS’s Strategic Planning Process

Source: GAO’s review of IRS’s planning documentation

This process provides IRS senior management with a means to reconcile

competing priorities with the realities of available resources. Through the

use of this process in developing its budget request for fiscal year 2003,

IRS identified a myriad of expected efficiency improvements,

technological enhancements, labor-saving initiatives, and workload

decreases that it projects will enable it to redirect about $158 million

(about 2,300 staff positions) to higher-priority areas. This accounted for

two out of every three additional staff that IRS believed was needed.

In February 2000, IRS implemented a new evaluation system for its

managers and in October 2001 implemented a new evaluation system for

front-line employees. These systems were developed to structurally align

performance expectations for managers and employees with IRS’s

strategic goals. An employee evaluation system can be a powerful tool in

New Employee Evaluation

System
Page 6 GAO-02-715T

helping an agency achieve its mission and ensuring employees at every

level of the organization are working toward common ends. Evaluation

systems should help employees understand their responsibilities and how

their day-to-day work contributes toward meeting their agency’s strategic

goals as well as providing a mechanism for giving employees candid,

specific feedback on how well they are meeting their rater’s expectations.

For agencies like the IRS that are undergoing a cultural change, the

employee evaluation system helps reinforce behaviors and actions that

support the agency’s mission. IRS recognizes that it may take a while

before the new evaluation systems achieves the intended results of

balancing taxpayer needs while at the same time enforcing the tax laws.

These expectations may appear to conflict so managers and employees

may need time to better understand what the new performance

expectations mean in terms of their daily work and which behaviors they

should change in order to put IRS’s new operational environment into

practice.

IRS has made progress in developing a way to measure the voluntary

compliance of individual taxpayers without placing an undue burden on

them. Each year billions of dollars in taxes are not voluntarily reported

and paid. To understand the overall extent of noncompliance, IRS plans to

implement its study of tax reporting compliance later this fall. The study

should provide IRS with data to update the criteria it uses to select tax

returns for audit and thereby reduce the number of compliant taxpayers

selected. Also, the study is intended to provide detailed information about

compliance, such as why taxpayers fail to comply with a specific tax law

provision. Having such information should enable IRS to make operational

changes such as modifying tax forms and instructions or to recommend

tax law changes that could improve compliance.

Over the past 3-plus years, IRS has made important progress in

establishing the infrastructure systems that are to provide the platforms

upon which future business applications will run. Establishing this

infrastructure is a necessary prerequisite to introducing the business

applications that are in turn intended to provide benefits to taxpayers and

IRS. During this time, IRS has also made important progress in delivering

two system applications—Customer Communications 2001 and Customer

Relationship Management Exam—that are producing benefits as of today.

For example, Customer Communications 2001, which is software

improvements to IRS’s customer service telephone system, was

implemented last summer and is now routing taxpayer calls with common

Progress in Measuring

Voluntary Compliance

Business Systems

Modernization
Page 7 GAO-02-715T

questions to automated menu driven information services, thereby freeing

IRS customer service representatives to answer complex or less common

inquiries.

IRS has also made progress in building and readying for deployment,

business applications to, among other things, replace existing antiquated

information technology systems that have hampered IRS’s ability to

improve customer service to taxpayers. In particular, IRS has been

building and is planning to pilot in July 2002, the first release of its

Customer Account Data Engine (CADE)—a modern relational database

designed to replace IRS’s tape-based data management system—for

taxpayers with simple tax returns. IRS plans to implement this release in

January 2003 in time for the 2003 filing season and plans to implement four

additional CADE releases, each for progressively more complex tax

returns, over the next 4 years with the goal of having CADE fully

implemented by 2006.

In addition, IRS has made progress in addressing our recommendations to

establish the modernization management controls needed to effectively

acquire and implement major systems. For example, we have consistently

recommended since 1995 that IRS develop and implement an enterprise

architecture (modernization blueprint) to guide and constrain the

acquisition of business systems modernization (BSM) systems; IRS

recently issued an updated a version of its Enterprise Architecture for how

it wants to transition its business systems environment, thus giving a highlevel roadmap to manage and control business and technological change.

The nature of IRS’s progress thus far should not be viewed solely in the

context of what taxpayer service and IRS efficiency benefits are being

realized today. Rather, this progress should also be viewed in terms of

laying the necessary foundation from which the benefits of future

applications can be realized. As a matter of fact, at this point in time, the

level of tangible mission-related benefits that have been realized from

modernization investments are not yet commensurate with costs incurred.

In our view, this is not unreasonable because as depicted in figure 2, the

expected return on these and future investments are to materialize later

when new business applications are brought on line.
Page 8 GAO-02-715T

Figure 2: Notional BSM Benefits Versus Costs

Source: GAO

For 2 consecutive years, IRS has produced financial statements that

present fairly, in all material respects, in conformity with U.S. generally

accepted accounting principles, IRS’s assets, liabilities, net position,

changes in net position, budgetary resources, reconciliation of net costs to

budgetary obligations, and custodial account activity. This unqualified

opinion was achieved through the extraordinary efforts of IRS’s senior

management and staff to compensate for serious internal control and

system deficiencies discussed in the risk section of this statement.

Additionally, IRS continues to make progress on several significant

internal control and compliance issues that contribute to its difficulties in

producing reliable and timely information.

Financial Reporting

cost

benefits

Time

Cost and Benefit Amounts

IRS is here
Page 9 GAO-02-715T

IRS faces risks in several areas that if not successfully managed could

threaten the agency’s ability to continue making progress modernizing.

The first area of risk involves the declines in compliance and collection

programs. Taxpayers’ willingness to voluntarily comply with the tax laws

depends in part on their confidence that their friends, neighbors, and

business competitors are paying their share of taxes.

To help provide that assurance, IRS operates six major compliance

programs. These programs (1) check for math errors and unpaid balances

during returns processing, (2) determine taxes due from apparent

nonfilers detected through computer matching, (3) determine taxes due

from apparent underreporters detected through computer matching, (4)

audit tax returns filed by individuals, (5) audit tax returns filed by

corporations, and (6) audit other tax returns such as estate and gift

returns.

IRS also operates two separate collection programs for dealing with

taxpayers who are delinquent in paying the taxes they owe. These

programs pursue collection through (1) telephone contacts with the

taxpayers and (2) personal visits with the taxpayers by IRS field staff.

As part of our ongoing work for the House Ways and Means Subcommittee

on Oversight, we identified large and pervasive declines across the

compliance and collection programs, except for returns processing,

between fiscal years 1996 and 2001. For example, individual and corporate

audit productivity as measured by cases closed per unit of staff time

declined 31 and 47 percent, respectively, while field and telephone

collection productivity declined over 20 percent. These productivity

declines coupled with reduced staffing has translated to declines in

coverage. That is, the proportion of individual and corporate tax returns

that were audited declined 63 and 60 percent, respectively, and the

percentage of delinquencies closed by telephone and field collection

declined by 15 and 45 percent, respectively. Figures 2, 5 and 6 in the

appendix provide additional data.

The decline in collection coverage reflected the collection programs’

inability to work a growing proportion of the delinquent cases referred

from the compliance programs. In response, by fiscal year 2001, IRS was

deferring collection action on about one out of three assigned

Risks to Continued

Modernization

Progress

Compliance and Collection

Declines
Page 10 GAO-02-715T

delinquencies. By the end of fiscal year 2001, we estimate that IRS had

deferred collecting taxes from about 1.3 million taxpayers1

 who owed

about $16.1 billion.2

 Absent significant operational change, IRS officials

said that they had little expectation of reopening many deferred collection

cases.

The declines in IRS’s compliance and collection programs affected

taxpayers in several ways.

• The likelihood that taxpayer noncompliance would be detected and

pursued by IRS declined. For example, coverage in the nonfiler program

declined by 69 percent by the end of fiscal year 2001.

• The length of time that taxpayers owed back taxes at the time they were

assigned to collection increased between 1996 and 2001 although IRS

intended that by deferring collection action on some older collection cases

it could get to newly assigned cases quicker.

• The amount of penalties and interest continued to accumulate on deferred

collection cases, making future payment increasingly demanding if

subsequently pursued by IRS.

• The likelihood that delinquent taxpayers would experience enforced

collection such as through levies placed on their wages or bank accounts

declined about 64 percent from 1996 to 2001, although there has been

some upturn from 2000 to 2001 (see figure 6 in the appendix).

Taken together, changes such as these have reduced the incentives for

voluntary compliance. Also, some available, but very limited, data suggest

that voluntary compliance may have begun to deteriorate. For example,

the number of apparent individual nonfilers increased about three and

one-half times faster than the individual tax filing population.

IRS managers are concerned about the decline in compliance and

collection programs and the extent that this threatens voluntary

compliance. A significant decline in voluntary compliance would

undermine IRS’s modernization effort.

 1

 Estimate is from a random sample. The 95-percent confidence interval is 1.25 million to

1.35 million taxpayers.

2

 Estimate is from a random sample. The 95-percent confidence interval is $14.8 billion to

$17.4 billion.
Page 11 GAO-02-715T

Since the start of IRS’ modernization program in late 1999, the program

has received almost $1 billion and expects to need about another $2.5

billion over the next 5 years. In fiscal year 2002, this funding supports 20

ongoing system acquisition projects, currently at different life-cycle stages

along with initiatives to develop the capabilities for managing the

acquisition projects.

Despite the important progress discussed above, IRS is not where it

committed to be in acquiring both infrastructure and application systems

and not where it needs to be in implementing modernization management

controls. This is because IRS’s first priority and emphasis has been to get

the newer, more modern systems—with their anticipated benefits to

taxpayers—up and running. In so doing, however, the establishment of

management capacity to ensure that these systems are introduced

successfully has not been given equal attention and thus has not kept up.

Simply stated, proceeding without these controls increases the risk of not

delivering promised system capabilities on time and within budget.

Moreover, these risks are amplified as IRS moves forward because

interdependencies among current ongoing projects and the complexity of

associated work activities to be performed, have and will continue to

increase dramatically as more system projects move into the latter stages

of their life cycles and are deployed. More recently, IRS has acknowledged

this risk and initiated efforts to better balance controls with project pace

and workload.

Testimony before you last spring outlined the same general concern that

we are stating today.3

 At that time, we feared that systems workload and

pace were getting too far ahead of the agency’s ability to deal with them

effectively, i.e., having proper management controls and capacity in place.

Since then, IRS has continued to move forward with its ongoing

infrastructure and business application projects while simultaneously

taking steps to implement missing management controls and capabilities.

During this time, however, the imbalance in project workload and needed

management capacity has remained a concern. More recently, our report

of this past February4

 recommended that the commissioner of internal

 3

 U.S. General Accounting Office, IRS Modernization: Continued Improvement in

Management Capability Needed to Support Long-Term Transformation, GAO-01-700T

(Washington, D.C.: May 8, 2001).

4

 U.S. General Accounting Office, Business Systems Modernization: IRS Needs to Better

Balance Management Capacity with Systems Acquisition Workload, GAO-02-356

(Washington, D.C.: February 28, 2002).

Business Systems

Modernization Risk
Page 12 GAO-02-715T

revenue reconsider the scope and pace of the program to better strike a

balance with the agency’s capacity to handle the workload. The

commissioner agreed, promising action in these areas. In particular, the

commissioner agreed to align the pace of the program with the maturity of

IRS’ controls and management capacity. The commissioner also made

correcting remaining management controls weaknesses a priority. Figure 3

illustrates IRS’s approach to developing projects and controls and the

degree to which projects have gotten ahead of controls.

Figure 3: Concurrent Development of Program-Level Controls and Projects

Source: GAO.

We nevertheless remain concerned because projects are entering critical

stages and not all essential management controls are in place and

functioning. In particular, in our ongoing work for the appropriations

IRS is here

Selected Key Projects

STIR

IRFoF (Release 1)

e-Services

CADE (Releases 1,2)

Enterprise Architecture

Selected Management Capabilities (e.g. Configuration Mgmt, Quality Assurance, Risk Mgmt)

Program Management Office

Program Management Capability

Denotes management capability fully established

1/01 7/01 7/02 1/03

Other projects (15)

1.0 1.1 2.0

Denotes Milestone 4 - completion of detailed design and development / beginning of deployment

Denotes Milestone 3 - beginning of detailed design and development

1/02 
Page 13 GAO-02-715T

subcommittees, we found that IRS is proceeding with building and

deploying systems before it has (1) fully implemented mature software

acquisition management processes, (2) developed and deployed a human

capital management strategy, and (3) established effective cost and

schedule estimating practices.

Weaknesses in any one of these modernization management controls

introduces an unnecessary element of risk to the BSM program, but the

combination of these weaknesses introduces a level of risk that increases

exponentially over time. IRS has reported that BSM projects have already

encountered cost, schedule, and/or performance shortfalls. Our analysis

has showed that weak management controls contributed directly to these

problems, or were the basis for prudent, proactive IRS decisionmaking not

to start or continue projects.

Given that IRS’ fiscal year 2002 BSM spending plan supports progress

towards the later phases of key projects and continued development of

other projects, it is likely that BSM projects will encounter additional cost,

schedule, and performance shortfalls. Figure 4 depicts this combination of

circumstances.
Page 14 GAO-02-715T

Figure 4: Current Time Line Depicting Escalating Program Execution Risk

Source: GAO.

IRS acknowledges these risks and is committed to addressing them. For

example, we recommended to IRS that it make implementing missing

controls a management priority5

 and as we recently reported,6 the

commissioner in 2001 hired an executive—with extensive private-sector

experience—to lead the BSM program office and this official has

developed plans to address each missing control, assigned responsibilities

and milestones for their completion, and is managing IRS’s progress in

executing the plans. These plans address all of our outstanding major

 5

 See, for example, U.S. General Accounting Office, Tax Systems Modernization: Results

of Review of IRS’ Third Expenditure Plan, GAO-01- 227 (Washington D.C.: January 22,

2001).

6

 U.S. General Accounting Office: Business Systems Modernization: Results of Review of

IRS’s March 2001 Expenditure Plan, GAO-01-716 (Washington D.C.: June 29, 2001), and

GAO-02-356.

IRS is here

Selected Key Projects

STIR

IRFoF (Release 1)

e-Services

CADE (Releases 1,2)

Enterprise Architecture

Selected Management Capabilities (e.g. Configuration Mgmt, Quality Assurance, Risk Mgmt)

Program Management Office

Program Management Capability

Denotes management capability fully established

1/01 7/01 7/02 1/03

Other projects (15)

1.0 1.1 2.0

Denotes Milestone 4 - completion of detailed design and development / beginning of deployment

Denotes Milestone 3 - beginning of detailed design and development

Execution Risk

1/02 
Page 15 GAO-02-715T

recommendations on human capital management, software acquisition,

information technology risk management, and enterprise architecture

compliance.

Timing is critical. While the lack of controls can be risky in projects’ early

stages, it is essential that such controls be in place when projects enter

detailed system design, development, and implementation. To mitigate this

added risk, IRS needs to fully implement the remaining management

controls that we have recommended.

As noted, IRS has made progress in revamping its performance

management system. However, several aspects of the system put IRS’s

ability to effectively measure, assess, and improve organizational and

employee performance at risk.

First, IRS needs to ensure that it has comparable performance measures

and sufficient data to assess performance. As part of its agencywide

efforts to develop balanced performance measures, IRS continues to

revise some measures and develop new ones to judge its performance.

Although we recognize the need to improve measures, changes interrupt

the possibility to establish trends and compare performance between

periods. In past years,7

 our assessment of IRS’s filing season performance

included comparisons of various performance measures against IRS’s

goals and prior years’ performance. We have been unable to make such a

comparison for some measures8

 because IRS (1) revised some measures

that it had been using to assess performance and established some new

measures and (2) had not established targets for new or revised measures.

For example, during the 2001 filing season, IRS made numerous changes,

such as renaming measures and revising formulas, to its measures for

processing paper returns, refunds, and remittances. Specifically, of 12

measures,9

 5 were new, 3 were revised, and 1 did not have a set target.

 7

 U.S. General Accounting Office, Tax Administration: Assessment of IRS’ 2000 Filing

Season, GAO-01-158, (Washington, D.C.: Dec. 22, 2000).

8

 U.S. General Accounting Office, Tax Administration: Assessment of IRS’ 2001 Filing

Season, GAO-02-144, (Washington, D.C.: Dec. 21, 2001).

9

 There were 12 measures listed in IRS’s Strategy and Program Plan, dated July 25, 2001 and

October 29, 2001.

Performance Management

Risks
Page 16 GAO-02-715T

Similarly, of the 15 telephone measures in place,10 7 were either new or

revised and 4 did not have targets set. Measures of telephone accuracy are

examples of how new and revised measures make it difficult to assess

IRS’s performance in providing quality telephone assistance over time.

Also, figure 4 of the appendix shows that because of changes made to its

telephone measures, IRS does not have sufficient time-series data for each

of its four measures of telephone accuracy to make a thorough assessment

of how well IRS is meeting its goal of providing “world class” telephone

service.

As a result, managers, Congress and other stakeholders may have

difficulty using information from new or revised measures. Although some

IRS managers may be aware of these changes to measures, we found little

or no documentation that disclosed the changes for outside stakeholders.

All in all, IRS officials agreed with our assessment that it is difficult to put

the reported results into context because of the absence of performance

goals and trend data. However, while the officials understood the

importance of such information, they also said they rely heavily on other

information, such as workload indicators and other management

information, that they have used for years to identify and correct problems

that could affect activities and help judge IRS’s overall success.

In addition to having comparable measures to gauge performance, IRS

needs to do more and better evaluations of its business practices so that it

can determine the factors that affect program performance and identify

ways to more effectively use resources and improve service. Over the past

year, we have reported on several of IRS’s efforts to improve the efficiency

of its programs that were hindered by insufficient program evaluation

efforts. These programs dealt with the Offer in Compromise Program,

telephone assistance accessibility and accuracy, and employment tax

compliance

• In our report on IRS’s Offer in Compromise Program, which allows

taxpayers to settle their tax liability for less than the full amount,11 we

pointed out that IRS lacked program evaluation plans for various

initiatives it undertook to try to reduce the offer inventory and

 10 There were 15 measures listed in the Strategy and Program Plan as of July 25, 2001. As of

October 29, 2001, one measure, “Toll-Free Automated Completion Rate,” was deleted.

11 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).
Page 17 GAO-02-715T

processing time. In addition, IRS lacked performance and cost data

needed to monitor program performance and had not set goals for offer

processing time that were based on taxpayer needs, other benefits, and

costs.

• Our report on IRS’s telephone assistance12 showed that IRS missed

some opportunities to analyze data to better understand the factors

affecting telephone performance, including the actions it took to

improve performance. IRS collected and analyzed a variety of data

about the key factors affecting telephone access and accuracy.

However, IRS officials sometimes reached conclusions about these key

factors without conducting analyses to test their conclusions.

• In our report on IRS’s efforts to improve the compliance of small

businesses with requirements that they report and pay employment

taxes,13 we noted that IRS had developed several new programs

designed to prevent or reduce employment tax delinquencies by

speeding up or enhancing the notification to certain groups of

businesses. However, IRS had not successfully followed through on its

plans to evaluate new early intervention programs.

In responding to our recommendations on these programs, IRS recognized

the necessity and importance of evaluating program performance and

agreed with our recommendations on ways to better assess and measure

program results.

As IRS moves forward with modernization, the capacity to conduct sound

performance evaluations on its current and planned operations will be one

building block for success. The Government Performance and Results Act

(GPRA) of 1993, IRS’s guidance, and our prior work all stress the need for

analyses of program performance to determine the factors affecting

performance and to identify opportunities for improvement.14 We

recognize that some analysis can be costly, and thus, the costs need to be

balanced against the benefits. Considering that IRS devotes considerable

 12 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).

13 U.S. General Accounting Office, Tax Administration: IRS’s Efforts to Improve

Compliance With Employment Tax Requirements Should Be Evaluated, GAO-02-92

(Washington, D.C.: Jan. 15, 2002).

14 U.S. General Accounting Office, Managing for Results: Challenges Agencies Face in

Producing Credible Performance Information, GAO/GGD-00-52 (Washington, D.C.: Feb. 4,

2000).
Page 18 GAO-02-715T

resources to many of its programs, the benefits of analysis —identifying

ways to more effectively use resources and improve service —could be

substantial.

Another performance management risk deals with IRS’s ability to link its

budget requests with program results. GPRA requires agencies to establish

linkages between resources and results so that the Congress and the

American public can gain a better understanding of what is being achieved

in relation to what is being spent. As we recently reported,15 IRS has made

progress in linking some of its budget justification to performance goals,

but in other instances the budget justification lacked performance goals or

contained inconsistencies between the budget request and performance

goals.

• IRS’s congressional justification has several good links between the

resources being requested and IRS’s performance goals. For example,

IRS’s budget includes an increase of 213 full-time equivalents 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.

• In some instances, IRS’s congressional justification contained no

performance goals against which the Congress can hold IRS

accountable. For example, the budget request includes increased

resources for systematic noncompliance problems identified by the

commissioner of Internal Revenue, such as for abusive corporate tax

shelters and failure to pay large accumulations of employment taxes,

yet it is unclear from IRS’s budget justification how many resources

IRS intends to devote to each of these problems. And, for none of these

areas does the budget justification include performance measures and

goals that Congress can use to assess IRS’s progress in addressing

these major compliance problems. In recent testimony, we suggested

that the House Ways and Means Subcommittee on Oversight ask IRS

for more specifics on its goals, performance measures and resource

plans.

A major purpose of GPRA and IRS’s strategic planning, budgeting, and

performance management system is to support better-informed decisions

 15U.S. General Accounting Office, Internal Revenue Service: Assessment of Budget Request

for Fiscal Year 2003 and Interim Results of 2002 Tax Filing Season, GAO-02-580T

(Washington, D.C.: Apr. 9, 2002).
Page 19 GAO-02-715T

on allocating scarce resources by focusing on the results likely to be

achieved and then supporting subsequent oversight and accountability by

establishing transparent measures to assess performance. IRS’s new

planning process and the linkages in its budget justification between some

of its resource requests and expected results are commendable steps to

implement this management approach. Improved linkages in IRS’s budget

justifications would better enable Congress to make difficult resource

allocation decisions and to hold IRS accountable for achieving results with

the resources it is provided.

Although for the second consecutive year, IRS was able to produce

financial statements covering its tax custodial and administrative activities

in fiscal years 2001 and 2000,16 that were fairly stated in all material

respects, this was only achieved because of the commitment of significant

staff resources, time, and the use of compensating processes to overcome

serious internal control and system deficiencies.

The major control and system deficiencies that we identified during our

most recently completed financial audit included:

• An inadequate financial reporting process;

• Weaknesses in controls over unpaid assessments;

• Weaknesses in controls over the identification and collection of tax

revenues due the federal government and issuance of tax refunds;

• Inadequate controls over property and equipment;

• Weaknesses in controls over its budgetary activity; and

• Weaknesses in computer security controls.

To overcome these problems, IRS relied on costly, time-consuming

processes; statistical projections; external contractors; substantial

adjustments; and monumental human efforts that extended nearly 4

months after the September 30, 2001, fiscal year-end. These costly efforts

produced tens of billions of dollars of adjustments and would not have

been necessary if IRS’s systems and controls operated effectively.

IRS’s current method of producing financial statements is not a workable

long-term solution to meeting its financial reporting responsibilities for

 16 U.S. General Accounting Office, Financial Audit: IRS’s Fiscal Years 2001 and 2000

Financial Statements, GAO-02-414 (Washington, D.C.: Feb. 27, 2002).

Financial Management

Risks
Page 20 GAO-02-715T

two basic reasons. First, the extent of manual review and changes to

financial records is so substantial, and requires so much commitment from

both management and the employees who do this time-pressure work, that

it is questionable whether this effort is sustainable year after year. Second,

the time frames acceptable for year-end financial reporting are being

compressed. The Office of Management and Budget has announced that,

by 2004, government agencies will be required to produce financial reports

within 6 weeks of year-end. The Treasury Department has established a

goal of meeting such a compressed schedule during 2002. Without

significant and systemic changes in how IRS processes transactions,

maintains its records, and reports its financial results to accompany its

extensive compensating processes, IRS’s ability to meet this accelerated

reporting deadline while sustaining an unqualified opinion on its financial

statements is questionable.

Moreover, weaknesses in controls and systems deficiencies threaten

modernization efforts.

• First, qualified staff whose input is critical to developing a modernized

financial management system are the same individuals responsible for

implementing the compensating processes to generate the annual financial

statements. The tremendous time and effort it takes to derive the financial

statements may make it impractical for these individuals to effectively

devote the time needed to ensure the new system meets ongoing reporting

needs.

• Second, because of the extent of adjustments to prevent misclassification

of financial data, unverified data extracts are of questionable utility to IRS

management. For example, without timely and reliable data on unpaid tax

assessments IRS is unable to promptly identify and focus collection efforts

on accounts most likely to prove collectible. Also, IRS has difficulties in

relating taxpayer accounts that may be jointly responsible for unpaid taxes

so that the correct liability of each taxpayer is readily discernable. This

has contributed to instances of both taxpayer burden and lost revenues to

the federal government.]

The challenge for IRS is to balance its short-term goals of improving its

compensating processes with its long-term needs of overhauling its

financial systems.

IRS is part way through what is intended to be a major organizational

transformation. Real progress has been made laying the foundation for a

more modern agency. To avoid delays in realizing the promise of

Concluding

Observations
Page 21 GAO-02-715T

modernization for improved service to taxpayers while ensuring

compliance with the tax laws, the new commissioner should be willing to

work within the existing general framework for modernization and be

willing to build on the foundation that has been laid. Progress will also

require successfully managing the risks outlined in our statement.

Mr. Chairman, this concludes our statement. We would be pleased to

respond to any questions that you or other committee members may have.
Page 22 GAO-02-715T

Overall, since the mid-1990s IRS has seen increased workload, decreased

staffing, and significant changes in the allocation of resources between

taxpayer assistance programs and its compliance and collection programs.

We selected data, presented in the following seven figures, to illustrate

some of the key trends at IRS since the mid-1990s.

Figure 1: IRS Workload as Measured by Returns Filed Has Increased While Total

Staffing Has Decreased

Source: GAO’s analysis of IRS’s data.

Appendix: Overview of Trends in Tax

Administration

Number of returns (millions) and staff (thousands)

0

50

100

150

200

250

1995 1996 1997 1998 1999 2000 2001

Fiscal year

Total IRS staff (average positions)

All tax returns (including individual, corporation, partnership, employment, estate, and other)
Page 23 GAO-02-715T

Figure 2: Enforcement Staffing Has Declined Proportionately More Than Total

Staffing

Source: GAO’s analysis of IRS’s data.

Number of employees

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1995 1996 1997 1998 1999 2000 2001

Fiscal year

Revenue agents

Revenue officers

Document matching staff (FY 2001 data not available)
Page 24 GAO-02-715T

Figure 3: Individual Electronic Returns More Than Tripled While Paper Returns

Decreased by About 15 Percent

Source: GAO’s analysis of IRS’s data.

Number of returns (millions)

0

20

40

60

80

100

120

1995 1996 1997 1998 1999 2000 2001

Fiscal year

Paper returns

Electronic returns
Page 25 GAO-02-715T

Figure 4: Telephone Accuracy Is Increasing

Note: IRS has two types of measures for assessing the accuracy of its responses to taxpayer calls

concerning (1) tax law issues and (2) IRS’s records on their accounts. The quality rate is the

percentage of calls in which assistors followed all IRS procedures for the call type and provided

correct answers. The correct response rate is the percentage of calls in which assistors provided

correct answers for the call type, discounting procedural errors. IRS has comparable data only for the

years shown.

Source: GAO’s analysis of IRS’s data.

Percentage

0

10

20

30

40

50

60

70

80

90

100

1999 2000 2001 2002

Filing season

Tax law quality rate

Account quality rate

Tax law correct response rate

Account correct response rate
Page 26 GAO-02-715T

Percent of returns filed

0

1

2

3

1996 1997 1998 1999 2000 2001

Fiscal year

Individual returns

Corporate returns

Partnership returns

Figure 5: Audit Rates Have Declined

Source: GAO’s analysis of IRS’s data.
Page 27 GAO-02-715T

Figure 6: Gap Between New Delinquency Cases and Delinquency Cases Closed;

Declines in the Use of Liens and Levies

Source: GAO’s analysis of IRS’s data.

Number of cases (thousands)

0

1000

2000

3000

4000

5000

6000

1996 1997 1998 1999 2000 2001

Fiscal year

New deliquency cases

Delinquency cases closed

Liens files

Levies issued
Page 28 GAO-02-715T

Figure 7: Raw Productivity Declined for Six of Eight Compliance and Collection

Programs

Source: GAO analysis of IRS data.

(440105)

Productivity index

0

20

40

60

80

100

120

140

1996 1997 1998 1999 2000 2001

Fiscal year

Returns processing

Underreporter

Nonfilers

Individual audit

Corporation audit

Other audit

Telephone collection

Field collection