Internal Revenue Service: Assessment of the Fiscal Year 2006 Budget Request
Published: 2005-04-27T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: The Internal Revenue Service (IRS) has been shifting its priorities from taxpayer service to enforcement and its management of Business Systems Modernization (BSM) from contractors to IRS staff. Although there are sound reasons for these adjustments, they also involve risks. With respect to the fiscal year 2006 budget request, GAO assessed (1) how IRS proposes to balance its resources between taxpayer service and enforcement programs and the potential impact on taxpayers, (2) status of IRS's efforts to develop and implement the BSM program, and (3) the progress IRS has made in implementing best practices in developing its Information Technology (IT) operations and maintenance budget.
section_title: What GAO Found
paragraphs: IRS's fiscal year 2006 budget request of $10.9 billion is an increase of 3.7 percent over last year's enacted levels. This includes an 8 percent increase for enforcement, and a 1 percent and 2 percent decrease for taxpayer service and BSM. However, the potential impact of these changes on taxpayers in either the short- or long-term is unclear, because IRS has not provided details of proposed taxpayer service reductions, and although it is developing long-term goals, they are not yet finalized. Because of the proposed reductions and new and improved taxpayer services in recent years, this is an opportune time to examine the menu of services IRS provides. It may be possible to maintain the overall level of service to taxpayers by offsetting reductions in some areas with new and improved service in other areas such as on IRS's Web site. Taxpayers and IRS are seeing some payoff from the BSM program, with the deployment of initial phases of several modernized systems in 2004. Nevertheless, the BSM program continues to be high-risk, in part, because projects have incurred significant cost increases and schedule delays and the program faces major challenges in areas such as human capital and requirements management. As a result of budget reductions and other factors, IRS has made major adjustments. It is too early to tell what effect these adjustments will have on the program, but they are not without risk and could potentially impact future budgets. Further, the BSM program is based on strategies developed years ago, which, coupled with the delays and changes brought on by budget reductions, indicates that it is time for IRS to revisit its long-term goals, strategy, and plans for BSM. Because of these challenges, IRS is redefining and refocusing the BSM program. Likewise, IRS has made progress in implementing best practices that would improve its budget development and support for its IT operations and maintenance request. In particular, the recent release of a modernized financial management system included a cost module. However, at this time, historical data is not yet available for IRS to use this module in formulating its IT operations and maintenance request.

section_title: Letter
paragraphs: We are pleased to present this statement for the record regarding the  Internal Revenue Service’s (IRS) fiscal year 2006 budget request and in  support of your April 7, 2005 hearing on IRS’s appropriations.
IRS is in the midst of making significant adjustments to its modernization  strategy to better serve taxpayers and ensure their compliance with the  nation’s tax laws.   It is now seven years since the passage of the Internal  Revenue Service Restructuring and Reform Act of 1998 (RRA 98) and IRS  is shifting its priorities from improving taxpayer service to strengthening  tax law enforcement efforts.   IRS is also adjusting its strategy for managing  its Business Systems Modernization (BSM) effort by shifting significant  program management responsibilities from contractor to IRS staff.   Although there are sound reasons for these adjustments, they also involve  risk.
We have reported that IRS has made progress improving taxpayer service  since the passage of RRA 98.  For example, IRS’s telephone assistance is  now more accessible and accurate.  Further, IRS is more efficient at  processing tax returns, in part, because of the growth of electronic filing,  and has cut processing staff.  IRS has also implemented some modernized  information systems and increased its capacity to manage large systems  acquisition and development programs. However, progress has not been  uniform. We have reported on large and pervasive declines in IRS’s tax law  enforcement programs after 1998.  We have also reported that a number of  systems modernization projects were over budget and behind schedule.
As noted, IRS is shifting its priorities to better address these problems.  The  risk, as IRS shifts its priorities towards enforcement, is that some of the  gains in the quality of taxpayer service could be surrendered.  There are  analogous risks associated with moving more of the management of BSM  in-house.
With these risks in mind, our statement for the record discusses IRS’s fiscal  year 2006 budget request.  To address your request to provide this  statement, we assessed (1) how IRS proposes to balance its resources  between taxpayer service and enforcement programs and the potential  impact on taxpayers, (2) the status of IRS’s efforts to develop and  implement the BSM program, and (3) the progress IRS has made in  implementing best practices for developing its information technology (IT)  operations and maintenance budget.
Our assessment of the budget request and BSM is based on a comparative  analysis of IRS’s fiscal year 2002 through 2006 budget requests, funding,  expenditures, other documentation, and interviews with IRS officials.  For  this assessment, we used historical budget and performance data from  reports and budget requests used by IRS, Department of Treasury, and  Office of Management and Budget (OMB).  In past work, we assessed IRS’s  budget and performance data. Since the data sources and procedures for  producing this year’s budget data have not significantly changed from prior  years, we determined that the data were sufficiently reliable for the  purposes of this report although for fiscal years 2005 and 2006 subject to  change. Regarding our analysis of IRS’s BSM program, we primarily used  the agency’s BSM expenditure plans to determine the status of the  program.  To assess the reliability of the cost and schedule information  contained in these plans, we interviewed applicable IRS officials to gain an  understanding of the data and discuss our use of that data. In addition, we  checked that information in the plans was consistent with information  contained in IRS internal briefings.  Accordingly, we determined that the  data in the plans were sufficiently reliable for purposes of this statement.  We performed our work in Washington, D.C. and Atlanta, Georgia from  December 2004 through March 2005, in accordance with generally  accepted government auditing standards.
In summary, our assessment shows that:  IRS’s 2006 fiscal year budget request reflects a continuing shift in  priorities from improving taxpayer service to strengthening  enforcement efforts, but the potential impact of these changes on  taxpayers in both the short- and long-term is unclear.  IRS is requesting  $10.9 billion, an increase of 3.7 percent over fiscal year 2005 enacted  levels.  This includes an 8 percent increase for enforcement, and a 1  percent and 2 percent decrease for taxpayer service and BSM,  respectively.  IRS has not finalized the details on where reductions in  taxpayer service would occur.  In addition, IRS is developing, but  currently lacks, long-term goals that can help IRS inform stakeholders,  including the Congress, and aid them in assessing performance and  making budget decisions. In light of the current budget environment and  IRS’s improvements in taxpayer service over the last several years, this  is an opportune time to reconsider the menu of services it provides. It  may be possible to maintain the overall level of assistance to taxpayers  by changing the menu of services offered, offsetting reductions in some  areas with new and improved service in other areas such as on IRS’s  Web site.
IRS has taken important steps forward towards implementing the BSM  program by delivering the initial phases of several modernized systems  in 2004 and early 2005. Nevertheless, BSM continues to be high risk  because, in part, its projects have incurred significant cost increases and  schedule delays, and the program continues to face major challenges. As  a result of funding reductions and other factors, IRS has made major  adjustments to the BSM program, including reducing the management  reserve and changing the mix and roles of contractor versus federal staff  used to manage the program. It is too early to tell what effect these  adjustments will ultimately have on the BSM program, but they are not  without risk, could potentially impact future budget requests, and will  delay the implementation of certain functionality that was intended to  provide benefit to IRS operations and taxpayers. Finally, the BSM  program is based on visions and strategies developed years ago, which,  coupled with the already significant delays the program has experienced  and the changes brought on by the budget reductions, indicates that it is  time for IRS to revisit its long-term goals, strategy, and plans for BSM,  including an assessment of when significant future BSM functionality  would be delivered. According to the Associate Chief Information  Officer (CIO) for BSM, IRS is redefining and refocusing this program.
IRS has made progress toward implementing investment management  best practices that would improve its budget development and support  for its IT operations and maintenance funding requests. For example,  the recent release of a new accounting system included an activity- based cost module, which IRS considered to be a necessary action to  implement these best practices. However, Office of the Chief Financial  Officer officials stated that IRS needs 3 years of actual costs to have the  historical data necessary to provide a basis for future budget estimates.  Accordingly, they expect that IRS will begin using the activity-based cost  module in formulating the fiscal year 2008 budget and will have the  requisite 3 years of historical data in time to develop the fiscal year 2010  budget.
subsections: section_title: IRS’s Budget Request Continues to Shift Priority from Taxpayer Service to Enforcement, but the Short- and Long-term Impacts on Taxpayers Are Unclear
paragraphs: IRS’s fiscal year 2006 budget request reflects a continuing shift in priorities  by proposing reductions in taxpayer service and increases in enforcement  activities.  The request does not provide details about how the reductions  will impact taxpayers in the short-term.  Nor does IRS have long-term goals;  thus the contribution of the fiscal year 2006 budget request to achieving  IRS’s mission in the long-term is unclear.    Because of budget constraints  and the progress IRS has made improving the quality of taxpayer services,  this is an opportune time to reconsider the menu of services IRS offers.
subsections: section_title: IRS Is Proposing Reductions in Taxpayer Service and BSM and Increases in Enforcement
paragraphs: IRS is requesting $10.9 billion, which includes just over a 1 percent  decrease for taxpayer service, a 2 percent decrease for BSM, and nearly an  8 percent increase for enforcement, as shown in table 1.  As table 1 further  shows, the changes proposed in the 2006 budget request continue a trend  from 2004.  In comparison to the fiscal year 2004 enacted budget, the 2006  budget request proposes almost 4 percent less for service, almost 49  percent less for BSM, and nearly 14 percent more for enforcement.
As table 1 also shows, taxpayer service sustained a reduction of $104  million or 2.8 percent between fiscal years 2004 and 2005.  According to IRS  officials, the majority of this reduction was the result of consolidating  paper-processing operations, shifting resources from service to  enforcement, and reducing some services.  IRS officials said that this  reduction is not expected to adversely impact the services they provide to  taxpayers but added that the agency cannot continue to absorb reductions  in taxpayer service without beginning to compromise some services.
For fiscal years 2005 and 2006, table 2 shows some details of changes in  both dollars and full-time equivalents (FTE). Both are shown because  funding changes do not translate into proportional changes in FTEs due to  cost increases for salaries, rent, and other items.  For example, the $39  million or 1.1 percent reduction in taxpayer service translates into a  reduction of 1,385 FTEs or 3.6 percent.  Similarly, the over $500 million or  7.8 percent increase in enforcement spending translates into an increase of  1,961 FTEs or 3.4 percent.
The difference between changes in dollars and FTEs could be even larger  because of unbudgeted expenses.  Unbudgeted expenses have consumed  some of IRS’s budget increases and internal savings increases over the last  few years.  Unbudgeted expenses include unfunded portions of annual  salary increases, which can be substantial given IRS’s large workforce, and  other costs such as higher-than-budgeted rent increases.  According to IRS  officials, these unbudgeted expenses accounted for over $150 million in  each of the last 4 years.
An IRS official also told us they anticipate having to cover unbudgeted  expenses in 2006.  As of March 2005, IRS officials were projecting  unbudgeted salary increases of at least $40 million.  This projection could  change since potential federal salary increases for 2006 have not been  determined.
section_title: IRS Is Proposing $39 Million Less for Taxpayer Service, but the Impact on Taxpayers Is Unclear
paragraphs: The budget request provides some detail on how IRS plans to absorb cost  increases in the taxpayer service budget.  IRS is proposing a gross  reduction of over $134 million in taxpayer service from reexamining the  budget’s base and plans to use more than $95 million of it to cover annual  increases such as salaries.  This leaves a net reduction of nearly $39 million  or 1.1 percent in the taxpayer service budget.  The extent to which IRS is  able to achieve the gross reductions will impact its ability to use the funds  as anticipated.
Decisions on how the $134 million gross reduction would be absorbed were  not finalized prior to releasing the budget.  According to IRS officials, some  of the reductions would result from efficiency gains such as reducing  printing and postage costs; however, others would result from reductions  in the services provided to taxpayers such as shortening the hours of toll- free telephone service operations.  The officials also said most decisions  have now been made about general areas for reduction and most changes  will not be readily apparent to taxpayers.
Although IRS has made general decisions about the reductions, many of the  details have yet to be determined.  Therefore, the extent of the impact on  taxpayers in the short term is unclear.  For example, IRS plans to reduce  dependence on field assistance, including walk-in sites, but has not reached  a final decision on how to reduce services. Table 3 provides further detail  on how IRS is proposing to reduce funding and resources for taxpayer  service.
IRS’s fiscal year 2006 budget request is the sixth consecutive year the  agency has requested additional staffing for enforcement. However, up  until last year, IRS was unable to increase enforcement staffing;  unbudgeted costs and other priorities consumed the budget increase.
IRS’s proposal for fiscal year 2006, if implemented as planned, would return  enforcement staffing in these occupations to their highest levels since 1999.   Of the more than $500 million increase requested for 2006, about $265  million would fund enforcement initiatives, over $182 million would be  used in part for salary increases, and over $55 million is a proposal to  transfer funding authority from the Department of Justice’s Interagency  Crime and Drug Enforcement. The $500 million increase would be  supplemented by internal enforcement savings of $88 million.  As is the  case with taxpayer service savings, the extent to which IRS achieves  enforcement savings will affect its ability to fund the new enforcement  initiatives.
The $265 million for new enforcement initiatives consist of:  $149.7 million and 920 FTEs to attack corrosive non-compliance activity  driving the tax gap such as abusive trusts and shelters, including  offshore credit cards and organized tax resistance;  $51.8 million and 236 FTEs to detect and deter corrosive corporate non- compliance to attack complex abusive tax avoidance transactions on a  global basis and challenge those who promote their use;  $37.9 million and 417 FTEs to increase individual taxpayer compliance  by identifying and implementing actions to address non-compliance  with filing requirements; increasing Automated Underreporter  resources to address the reporting compliance tax gap; increasing audit  coverage; and expanding collection work in walk-in sites;  $14.5 million and 77 FTEs to combat abusive transactions by entities  with special tax status by initiating examinations more promptly,  safeguarding compliant customers from unscrupulous promoters, and  increasing vigilance to ensure that the assets of tax-exempt  organizations are put to their intended tax-preferred purpose and not  misdirected to fund terrorism or for private gain; and  $10.8 million and 22 FTEs to curtail fraudulent refund crimes.
The $88 million in internal savings would be reinvested to perform the  following activities:  $66.7 million and 585 FTEs to devote resources to front-line   $14.9 million and 156 FTEs to, in part, address bankruptcy-related   $6.7 million and 52 FTEs to address complex, high-risk issues such as  compliance among tax professionals.
In the past, IRS has had trouble achieving enforcement staffing increases  because other priorities, including unbudgeted expenses, have absorbed  additional funds.  IRS achieved some gains in 2004 and expects modest  gains in 2005.  Figure 1 shows that the number of revenue agents (those  who audit complex returns), revenue officers (those who do field  collection work), and special agents (those who perform criminal  investigations) decreased over 21 percent between 1998 and 2003, but  increased almost 6 percent from 2003 to 2004.
IRS’s recent gains in enforcement staffing are encouraging, as tax law  enforcement continues to remain an area of high risk for the federal  government because the resources IRS has dedicated to enforcing the tax  laws have declined, while IRS’s enforcement workload—measured by the  number of taxpayer returns filed—has continually increased.   Figure 2  shows the trend in field, correspondence, and total audit rates since 1995.   Field audits involve face-to-face audits and correspondence audits are  typically less complex involving communication through notices.  IRS  experienced steep declines in audit rates from 1995 to 1999, but the audit  rate—the proportion of tax returns that IRS audits each year—has slowly  increased since 2000.  The figure shows that the increase in total audit rates  of individual filers has been driven mostly by correspondence audits, while  more complex field audits, continue to decline.
The link between the decline in enforcement staff and the decline in  enforcement actions, such as audits, is complicated, and the real impact on  taxpayers’ rate of voluntary compliance is not known.  This leaves open the  question of whether the declines in IRS’s enforcement programs are  eroding taxpayers’ incentives to voluntarily comply.  IRS’s National  Research Program (NRP) recently completed a study on compliance by  individual tax filers based on tax data provided on 2001 tax returns.  The  study estimated that the tax gap—the difference between what taxpayers  owe and what they pay—is at least $312 billion per year as of 2001 and  could be as large as $353 billion.  This study is important for several  reasons beyond measuring compliance.  It is intended to help IRS better  target its enforcement actions, such as audits, on non-compliant taxpayers,  and minimize audits of compliant taxpayers.  It should also help IRS better  understand the impact of taxpayer service on compliance.
section_title: IRS Is Developing Long- term Goals That Can Be Used to Assess Performance and Make Budget Decisions
paragraphs: IRS is developing but currently lacks long-term goals that can be used to  assess performance and make budget decisions.  Long-term goals and  results measurement are a component of the statutory strategic planning  and management framework that the Congress adopted in the Government  Performance and Results Act of 1993.  As a part of this comprehensive  framework, long-term goals that are linked to annual performance  measures can help guide agencies when considering organizational  changes and making resource decisions.
A recent Program Assessment Rating Tool (PART) review conducted by  OMB reported that IRS lacks long-term goals.  As a result, IRS has been  working to identify and establish long-term goals for all aspects of its  operations for over a year.  IRS officials said these goals will be finalized  and provided publicly as an update to the agency’s strategic plan before  May 2005.
For IRS and its stakeholders, such as the Congress, long-term goals can be  used to assess performance and progress towards these goals, and  determine whether budget decisions contribute to achieving those goals.
Without long-term goals, the Congress and other stakeholders are  hampered in evaluating whether IRS is making satisfactory long-term  progress.  Further, without such goals, the extent to which IRS’s 2006  budget request would help IRS achieve its mission over the long-term is  unclear.
section_title: This Is an Opportune Time to Review IRS’s Menu of Taxpayer Services
paragraphs: For at least two reasons, this is an opportune time to review the menu of  taxpayer services that IRS provides.  First, IRS’s budget for taxpayer  services was reduced in 2005 and an additional reduction is proposed for  2006.  As already discussed, these reductions have forced IRS to propose  scaling back some services.  Second, as we have reported, IRS has made  significant progress in improving the quality of its taxpayer services.  For  example, IRS now provides many Internet services that did not exist a few  years ago and has noticeably improved the quality of telephone services.    This opens up the possibility of maintaining the overall level of taxpayer  service but with a different menu of service choices.  Cuts in selected  services could be offset by the new and improved services.
Generally, as indicated in the budget, the menu of taxpayer services that  IRS provides covers assistance, outreach, and processing.  Assistance  includes answering taxpayer questions via telephone, correspondence, and  face-to-face at its walk-in sites. Outreach includes educational programs  and the development of partnerships.  Processing includes issuing millions  of tax refunds.
When considering program reductions, we support a targeted approach  rather than across-the-board cuts.  A targeted approach helps reduce the  risk that effective programs are reduced or eliminated while ineffective or  lower priority programs are maintained.
With the above reasons in mind for reconsidering IRS’s menu of services,  we have compiled a list of options for targeted reductions in taxpayer  service.  The options on this list are not recommendations but are intended  to contribute to a dialogue about the tradeoffs faced when setting IRS’s  budget.   The options presented meet at least one of the following criteria  that we generally use to evaluate programs or budget requests.  These  criteria include that the activity   duplicates other efforts that may be more effective and/or efficient;   historically does not meet performance goals or provide intended  results as reported by GAO, the Treasury Inspector General for Tax  Administration (TIGTA), IRS, or others;   experiences a continued decrease in demand;   lacks adequate oversight, implementation and management plans, or  structures and systems to be implemented effectively;   has been the subject of actual or requested funding increases that  cannot be adequately justified; or  has the potential to make an agency more self-sustaining by charging  user fees for services provided.
We recognize that the options listed below involve tradeoffs.  In each case,  some taxpayers would lose a service they use.  However, the savings could  be used to help maintain the quality of other services.   We also want to give  IRS credit for identifying savings, including some on this list.   The options  include  closing walk-in sites.  Taxpayer demand for walk-in services has  continued to decrease and staff answer a more limited number of tax  law questions in person than staff answer via telephone.    limiting the type of telephone questions answered by IRS assistors.  IRS  assistors still answer some refund status questions even though IRS  provides automated answers via telephone and its Web site.    mandating electronic filing for some filers such as paid preparers or  businesses.  As noted, efficiency gains from electronic filing have  enabled IRS to consolidate paper processing operations.   charging for services.  For example, IRS provides paid preparers with  information on federal debts owed by taxpayers seeking refund  anticipation loans.
section_title: Progress in BSM Implementation, but the Program Remains High Risk and Budget Reductions Have Resulted in Significant Adjustments
paragraphs: Although IRS has implemented important elements of the BSM program,  much work remains. In particular, the BSM program remains at high risk  and has a long history of significant cost overruns and schedule delays.  Furthermore, budget reductions have resulted in significant adjustments to  the BSM program, although it is too early to determine their ultimate effect.
subsections: section_title: IRS Has Made Progress in Implementing BSM, but Much Work Remains
paragraphs: IRS has long relied on obsolete automated systems for key operational and  financial management functions, and its attempts to modernize these aging  computer systems span several decades. IRS’s current modernization  program, BSM, is a highly complex, multibillion-dollar program that is the  agency’s latest attempt to modernize its systems. BSM is critical to  supporting IRS’s taxpayer service and enforcement goals. For example,  BSM includes projects to allow taxpayers to file and retrieve information  electronically and to provide technology solutions to help reduce the  backlog of collections cases. BSM is important for another reason. It allows  IRS to provide the reliable and timely financial management information  needed to account for the nation’s largest revenue stream and better enable  the agency to justify its resource allocation decisions and congressional  budgetary requests.
Since our testimony before this subcommittee on last year’s budget  request, IRS has deployed initial phases of several modernized systems  under its BSM program. The following provides examples of the systems  and functionality that IRS implemented in 2004 and the beginning of 2005.
Modernized e-File (MeF). This project is intended to provide electronic  filing for large corporations, small businesses, and tax-exempt  organizations. The initial releases of this project were implemented in  June and December 2004, and allowed for the electronic filing of forms  and schedules for the form 1120 (corporate tax return) and form 990  (tax-exempt organizations’ tax return). IRS reported that, during the  2004 filing season, it accepted over 53,000 of these forms and schedules  using MeF.   e-Services. This project created a Web portal and provided other  electronic services to promote the goal of conducting most IRS  transactions with taxpayers and tax practitioners electronically. IRS  implemented e-Services in May 2004. According to IRS, as of late March  2005, over 84,000 users have registered with this Web portal.
Customer Account Data Engine (CADE). CADE is intended to replace  IRS’s antiquated system that contains the agency’s repository of  taxpayer information and, therefore, is the BSM program’s linchpin and  highest priority project. In July 2004 and January 2005, IRS implemented  the initial releases of CADE, which have been used to process filing year  2004 and 2005 1040EZ returns, respectively, for single taxpayers with  refund or even-balance returns. According to IRS, as of March 16, 2005,  CADE had processed over 842,000 tax returns so far this filing season.
Integrated Financial System (IFS). This system replaces aspects of  IRS’s core financial systems and is ultimately intended to operate as its  new accounting system of record. The first release of this system  became fully operational in January 2005.
Although IRS is to be applauded for delivering such important  functionality, the BSM program is far from complete. Future deliveries of  additional functionality of deployed systems and the implementation of  other BSM projects are expected to have a significant impact on IRS’s  taxpayer services and enforcement capability. For example, IRS has  projected that CADE will process about 2 million returns in the 2005 filing  season. However, the returns being processed in CADE are the most basic  and constitute less than 1 percent of the total tax returns expected to be  processed during the current filing season. IRS expects the full  implementation of CADE to take several more years. Another BSM  project—the Filing and Payment Compliance (F&PC) project—is expected  to increase (1) IRS’s capacity to treat and resolve the backlog of delinquent  taxpayer cases, (2) the closure of collection cases by 10 million annually by  2014, and (3) voluntary taxpayer compliance.  As part of this project, IRS  plans to implement an initial limited private debt collection capability in  January 2006, with full implementation of this aspect of the F&PC project  to be delivered by January 2008 and additional functionality to follow in  later years.
section_title: BSM Program Has History of Cost Increases and Schedule Delays and Is High Risk
paragraphs: The BSM program has a long history of significant cost increases and  schedule delays, which, in part, has led us to report this program as high-  risk since 1995. Appendix II provides the history of the BSM life-cycle cost  and schedule variances. In January 2005 letters to congressional  appropriation committees, IRS stated that it had showed a marked  improvement in significantly reducing its cost variances. In particular, IRS  claimed that it reduced the variance between estimated and actual costs  from 33 percent in fiscal year 2002 to 4 percent in fiscal year 2004.  However, we do not agree with the methodology used in the analysis  supporting this claim. Specifically, (1) the analysis did not reflect actual  costs, instead it reflected changes in cost estimates (i.e., budget  allocations) for various BSM projects; (2) IRS aggregated all of the changes  in the estimates associated with the major activities for some projects,  such as CADE, which masked that monies were shifted from future  activities to cover increased costs of current activities; and (3) the  calculations were based on a percentage of specific fiscal year  appropriations, which does not reflect that these are multiyear projects.
In February 2002 we expressed concern over IRS’s cost and schedule  estimating and made a recommendation for improvement. IRS and its  prime systems integration support (PRIME) contractor have taken action  to improve their estimating practices, such as developing a cost and  schedule estimation guidebook and developing a risk-adjustment model to  include an analysis of uncertainty. These actions may ultimately result in  more realistic cost and schedule estimates, but our analysis of IRS’s  expenditure plans over the last few years shows continued increases in  estimated project life-cycle costs (see fig. 3).
The Associate CIO for BSM stated that he believes that IRS’s cost and  schedule estimating has improved in the past year. In particular, he pointed  out that IRS met its cost and schedule goals for the implementation of the  latest release of CADE, which allowed the agency to use this system to  process certain 1040EZ forms in the 2005 filing season. It is too early to tell  whether this signals a fundamental improvement in IRS’s ability to  accurately forecast project costs and schedules.
The reasons for IRS’s cost increases and schedule delays vary. However, we  have previously reported that they are due, in part, to weaknesses in  management controls and capabilities. We have previously made  recommendations to improve BSM management controls, and IRS has  implemented or begun to implement these recommendations. For example,  in February 2002, we reported that IRS had not yet defined or implemented  an IT human capital strategy, and recommended that IRS develop plans for  obtaining, developing, and retaining requisite human capital resources. In  September 2003, TIGTA reported that IRS had made significant progress in  developing a human capital strategy but that it needed further  development. In August 2004, the current Associate CIO for BSM identified  the completion of a human capital strategy as a high priority. Among the  activities that IRS is implementing are prioritizing its BSM staffing needs  and developing a recruiting plan. IRS has also identified, and is addressing,  other major management challenges in areas such as requirements,  contract, and program management. For example, poorly defined  requirements have been among the significant weaknesses that have been  identified as contributing to project cost overruns and schedule delays. As  part of addressing this problem, in March 2005, the IRS BSM office  established a requirements management office, although a leader has not  yet been hired.
section_title: IRS Is Adjusting the BSM Program in Response to Budget Reductions
paragraphs: The BSM program is undergoing significant changes as it adjusts to  reductions in its budget. Figure 4 illustrates the BSM program’s requested  and enacted budgets for fiscal years 2004 through 2006. For fiscal year  2005, IRS received about 29 percent less funding than it requested (from  $285 million to $203.4 million). According to the Senate report for the fiscal  year 2005 Transportation, Treasury, and General Government  appropriations bill, in making its recommendation to reduce BSM funding,  the Senate Appropriations Committee was concerned about the program’s  cost overruns and schedule delays. In addition, the committee emphasized  that in providing fewer funds, it wanted IRS to focus on its highest priority  projects, particularly CADE. In addition, IRS’s fiscal year 2006 budget  request reflects an additional reduction of about 2 percent, or about $4.4  million, from the fiscal year 2005 appropriation.
It is too early to tell what effect the budget reductions will ultimately have  on the BSM program. However, the significant adjustments that IRS is  making to the program to address these reductions are not without risk,  could potentially impact future budget requests, and will delay the  implementation of certain functionality that was intended to provide  benefit to IRS operations and the taxpayer. For example:   Reductions in Management reserve/project risk adjustments. In  response to the fiscal year 2005 budget reduction, IRS reduced the  amount that it had allotted to program management reserve and project  risk adjustments by about 62 percent (from about $49.1 million to about  $18.6 million). If BSM projects have future cost overruns that cannot  be covered by the depleted reserve, this reduction could result in (1)  increased budget requests in future years or (2) delays in planned future  activities (e.g., delays in delivering promised functionality) to use those  allocated funds to cover the overruns.
Shifts of BSM management responsibility from the PRIME contractor  to IRS.  Due to budget reductions and IRS’s assessment of the PRIME  contractor’s performance, IRS decided to shift significant BSM  responsibilities for program management, systems engineering, and  business integration from the PRIME contractor to IRS staff. For  example, IRS staff are assuming responsibility for cost and schedule  estimation and measurement, risk management, integration test and  deployment, and transition management. There are risks associated  with this decision. To successfully accomplish this transfer, IRS must  have the management capability to perform this role. Although the BSM  program office has been attempting to improve this capability through,  for example, implementation of a new governance structure and hiring  staff with specific technical and management expertise, IRS has had  significant problems in the past managing this and other large  development projects, and acknowledges that it has major challenges to  overcome in this area.
Suspension of the Custodial Accounting Project (CAP). Although the  initial release of CAP went into production in September 2004, IRS has  decided not to use this system and to stop work on planned  improvements due to budget constraints. According to IRS, it made this  decision after it evaluated the business benefits and costs to develop  and maintain CAP versus the benefits expected to be provided by other  projects, such as CADE. Among the functionality that the initial releases  of CAP were expected to provide were (1) critical control and reporting  capabilities mandated by federal financial management laws; (2) a  traceable audit trail to support financial reporting; and (3) a subsidiary  ledger to accurately and promptly identify, classify, track, and report  custodial revenue transactions and unpaid assessments. With the  suspension of CAP, it is now unclear how IRS plans to replace the  functionality this system was expected to provide, which was intended  to allow the agency to make meaningful progress toward addressing  long-standing financial management weaknesses. IRS is currently  evaluating alternative approaches to addressing these weaknesses.
Reductions in planned functionality. According to IRS, the fiscal year  2006 funding reduction will result in delays in planned functionality for  some of its BSM projects. For example, IRS no longer plans to include  Form 1041 (the income tax return for estates and trusts) in the fourth  release of Modernized e-File, which is expected to be implemented in  fiscal year 2007.
The BSM program is based on visions and strategies developed in 2000 and  2001. The age of these plans, in conjunction with the significant delays  already experienced by the program and the substantive changes brought  on by budget reductions, indicate that it is time for IRS to revisit its long- term goals, strategy, and plans for BSM. Such an assessment would include  an evaluation of when significant future BSM functionality would be  delivered. IRS’s Associate CIO for BSM has recognized that it is time to  recast the agency’s BSM strategy because of changes that have occurred  subsequent to the development of the program’s initial plans. According to  this official, IRS is redefining and refocusing the BSM program, and he  expects this effort to be completed by the end of this fiscal year.
section_title: Additional Actions Needed to Improve Budgeting for IT Operations and Maintenance
paragraphs: IRS has requested about $1.62 billion for IT operations and maintenance in  fiscal year 2006, within its proposed new Tax Administration and  Operations account. Under the prior years’ budget structure, these funds  were included in a separate account, for which IRS received an  appropriation of about $1.59 billion in fiscal year 2005. The $1.62 billion  requested in fiscal year 2006 is intended to fund the personnel costs for IT  staff (including staff supporting the BSM program) and activities such as IT  security, enterprise networks, and the operations and maintenance costs of  its current systems. We have previously expressed concern that IRS does  not employ best practices in the development of its IT operations and  maintenance budget request. Although IRS has made progress in  addressing our concern, more work remains.
The Paperwork Reduction Act (PRA) of 1995  requires federal agencies to  be accountable for their IT investments and responsible for maximizing the  value and managing the risks of their major information systems initiatives.  The Clinger-Cohen Act of 1996 establishes a more definitive framework  for implementing the PRA’s requirements for IT investment management. It  requires federal agencies to focus more on the results they have achieved  and introduces more rigor and structure into how agencies are to select  and manage IT projects. In addition, 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  identify operations and maintenance projects and systems for inclusion   assess these projects or systems on the basis of expected costs,  benefits, and risks to the organization;  analyze these projects as a portfolio of competing funding options; and  use this information to develop and support budget requests.
This focus on projects, their outcomes, and risks as the basic elements of  analysis and decision making is incorporated in the IT investment  management approach that is recommended by OMB and GAO.  By using  these proven investment management approaches for budget formulation,  agencies have a systematic method, on the basis of risk and return on  investment, to justify what are typically substantial information systems  operations and maintenance budget requests.
In our assessment of IRS’s fiscal year 2003 budget request, we reported that  the agency did not develop its information systems operations and  maintenance request in accordance with the investment management  approach used by leading organizations. We recommended that IRS  prepare its future budget requests in accordance with these best  practices. To address our recommendation, IRS agreed to take a variety of  actions, which it has made progress in implementing. For example, IRS  stated that it planned to develop an activity-based cost model to plan,  project, and report costs for business tasks/activities funded by the  information systems budget. The recent release of IFS included an activity- based cost module, but IRS does not currently have historical cost data to  populate this module. According to officials in the Office of the Chief  Financial Officer, IRS is in the process of accumulating these data. These  officials stated that IRS needs 3 years of actual costs to have the historical  data that would provide a basis for future budget estimates. Accordingly,  these officials expected that IRS would begin using the IFS activity-based  cost module in formulating the fiscal year 2008 budget request and would  have the requisite 3 years’ of historical data in time to develop the fiscal  year 2010 budget request. In addition, IRS planned to develop a capital  planning guide to implement processes for capital planning and investment  control, budget formulation and execution, business case development,  and project prioritization. IRS has developed a draft guide, which is  currently under review by IRS executives, and IRS expects it to become  policy on October 1, 2005. Although progress has been made in  implementing best practices in the development of the IT operations and  maintenance budget, until these actions are completely implemented IRS  will not be able to ensure that its request is adequately supported.
section_title: Conclusions
paragraphs: As IRS shifts its priorities to enforcement and faces tight budgets for  service, the agency will be challenged to maintain the gains it has made in  taxpayer service.  In order to avoid a “swinging pendulum,” where  enforcement gains are achieved at the cost of taxpayer service and vice  versa, IRS and the Congress would benefit from a set of agreed-upon long- term goals.  Long-term goals would provide a framework for assessing  budgetary tradeoffs between taxpayer service and enforcement and  whether IRS is making satisfactory progress towards achieving those goals.   Similarly, long-term goals could help identify priorities within the taxpayer  service and enforcement functions.  For example, if the budget for taxpayer  service were to be cut and efficiency gains did not offset the cut, long-term  goals could help guide decisions about whether to make service cuts across  the board or target selected services.  To its credit, IRS has been developing  a set of long-term goals, so we are not making a recommendation on goals.   However, we want to underscore the importance of making the goals  public in a timely fashion, as IRS has planned.  The Congress would then  have an opportunity to review the goals and start using them as a tool for  holding IRS accountable for performance.
In addition, the Congress would benefit from more information about the  short-term impacts of the 2006 budget request on taxpayers.  The 2006  budget request cites a need for reducing the hours of telephone service and  scaling back walk-in assistance but provides little additional detail.   Without more detail about how taxpayers will be affected, it is difficult to  assess whether the 2006 proposed budget would allow IRS to achieve its  stated intent of both maintaining a high level of taxpayer service and  increasing enforcement.
BSM and related initiatives such as electronic filing hold the promise of  delivering further efficiency gains that could offset the need for larger  budget increases to fund taxpayer service and enforcement.  Today,  taxpayers have seen payoffs from BSM; however, the program is still high  risk and budget reductions have caused substantive program changes.  IRS  has recognized it is time to revisit its long-term BSM strategy and is  currently refocusing the program.   As we did with long-term goals above,  we want to underscore the importance of timely completion of the revision  of the BSM strategy.
section_title: Recommendation
paragraphs: In a related statement (GAO-05-416T), GAO recommended that the  Commissioner of Internal Revenue supplement the 2006 budget request  with more detailed information on how proposed service reductions would  impact taxpayers.
section_title: Description of IRS’s Proposed Budget Structure
paragraphs: IRS's proposed new budget structure as depicted in figure 7 combines the  three major appropriations that the agency has had in the past— Processing, Assistance, and Management; Tax Law Enforcement; and  Information Systems into one appropriation called Tax Administration and  Operations. The Business Systems Modernization and Health Insurance  Tax Credit Administration appropriations accounts remain unchanged.   The Tax Administration and Operations appropriation is divided among  eight critical program areas. These budget activities focus on Assistance,  Outreach, Processing, Examination, Collection, Investigations, Regulatory  Compliance, and Research. According to IRS, as it continues to move  forward with developing and implementing this new structure, these  program areas and the associated resource distributions will be refined to  provide more accurate costing.
IRS reported that the new budget structure has a more direct relationship  to its major program areas and strategic plan.  We did not evaluate IRS's  proposed budget structure as part of this engagement because it was not  within the scope of our review.   However, we have recently completed a  study on the administration's broader budget restructuring effort.  In that  study we say that, going forward, infusing a performance perspective into  budget decisions may only be achieved when the underlying information  becomes more credible and used by all major decision makers.  Thus, the  Congress must be considered a partner.  In due course, once the goals and  underlying data become more compelling and used by the Congress,  budget restructuring may become a better tool to advance budget and  performance integration.
section_title: BSM Project Life Cycle Cost/Schedule Variance and Benefits Summary
paragraphs: The table below shows the life-cycle variance in cost and schedule  estimates for completed and ongoing Business Systems Modernization  (BSM) projects, based on data contained in IRS's expenditure plans. These  variances are based on a comparison of IRS's initial and revised (as of July  2004) cost and schedule estimates to complete initial operation or full  deployment of the projects.
section_title: How IRS Allocated Expenditures FTEs in Fiscal Year 2004
paragraphs: Figures 6 and 7 illustrate how the Internal Revenue Service (IRS) allocated  expenditures and full-time equivalents (FTEs) in fiscal year 2004.  Figure 8  shows total expenditures.  The percentage of expenditures devoted to  contracts decreased from 9 percent in 2002 to 5 percent in 2004, because of  fewer private contracts.  The percentage of expenditures devoted to other  non-labor costs increased from 8 percent in 2002 to 12 percent in 2004,  according to IRS officials, due to of increases in miscellaneous costs.
Figure 9 shows IRS’s total FTEs.  Since 2002, FTEs have decreased slightly  from 99,180 in 2002 to 99,055 in 2004.  We previously reported that  processing FTEs declined 1 percentage point between 2002 and 2003.   Between 2003 and 2004, IRS’s allocation of FTEs remained similar but with  a 1 percent increase in enforcement activities in conducting examinations,  and in management and other services.