IRS 2014 Budget: Improvements Made to Budget Request and Cost Estimate, but Further Actions Needed
Released: 2013-09-26T00:00:00

Letter

Background

IRS Budget Formulation and Execution Structures

IRS formulates its budget at three levels: appropriation account, budget activity, and program activity, as shown in figure 1. (See appendix II for the non-interactive figure of IRS’s budget formulation structure.) The annual budget request for IRS presents funding and FTE data at the appropriation and budget activity levels. IRS formulates its budget to align with its strategic goals, which is an intended outcome of the Government Performance and Results Act of 1993 (GPRA).

IRS executes its budget by allocating funds from its appropriation accounts to fund centers. Fund centers manage and distribute funds and allocate funds to sub-units, known as cost centers, where funds are obligated.

IRS’s appropriation accounts align with its organizational structure at the highest level. For example, IRS has an Operations Support appropriation account and an Operations Support commissioner-level organization. In addition, IRS’s organizational structure tracks roughly to its budget execution structure, which is made up of three types of fund centers: (1) support, (2) functional, and (3) operating. (See figure 2.)

The lower levels of the budget formulation and budget execution structures include (1) program activities, which break down the budget activities and are listed above; and (2) organizational entities and other efforts of interest, which are not discrete categories and are different perspectives of IRS’s organizational structure. For example, Wage and Investment is one division within IRS and can be referred to as an organizational entity, while identity theft would be considered an area of interest that crosses divisions within IRS, including Wage and Investment.

Alignment of Budget Execution and Formulation Processes

Prior to the preparation of the annual budget request, IRS budget staff ensure that FTE movements between budgetary accounts made during the fiscal year (e.g., shifting staff to work on different issues) match up with base budget resources assigned to each account. This review (which is conducted by the IRS Corporate Budget Office in coordination with business units) is necessary because business units may have added or eliminated staff during the course of the fiscal year, which can result in a misalignment of funding and FTEs during budget formulation. Further, the review ensures that FTEs—which represent the majority of IRS’s budgetary resources—are fully funded by appropriation accounts and that salary and benefits are aligned with current FTE levels.

IRS Can Report Some Program-Level Obligations and FTE Data

Obligations and FTE Data Are Available for Some Program Activities, Organizational Entities, and Efforts of Interest with Limitations

In its annual budget request, IRS provides funding information at the appropriation account and budget activity levels, but not at the more detailed program activity level. IRS officials stated that they could provide more information at the program activity level; however, reporting on requested funding amounts for program activities could limit IRS’s flexibility to reprogram funds given statutory restrictions. Still, as we reported in May 2010, IRS could provide additional information that highlights new program activities or those that are proposed for either expansion or reduction. This more detailed information could increase transparency and demonstrate the agency’s priorities to congressional decision makers.

As an alternative to more detailed information on requested funds, IRS Corporate Budget officials told us they could provide prior year obligations and FTE data in greater detail than reported in the annual budget request, including information for some program activities, organizational entities, and other efforts of interest. For eight areas we selected as examples, IRS officials confirmed that they could provide fiscal year 2012 obligations data for six and partial information for one. They could not provide information for one, as shown in table 1.

According to IRS officials, obligations data for identity theft are only partially available because IRS tracks obligations attributed to identity theft from its Wage and Investment fund center, which handles most of its identity theft workload. However, IRS does not track identity theft-related obligations incurred by other IRS business units. According to a senior official, IRS plans to establish a Servicewide internal order code for identity theft at the beginning of fiscal year 2014 because it has become a long-term priority. Officials said they were not able to provide fiscal year 2012 obligations data for the offshore voluntary disclosure program because they had not established a mechanism to track it (in part because the program was operated as a short-term effort in the past and, according to officials, has only recently been made permanent.) IRS has not decided if it will track obligations for the offshore voluntary disclosure program in the future.

According to IRS officials, IRS obligations data for program activities, organizational entities, and other efforts of interest have some limitations. For example, the data do not include indirect costs, including costs associated with IRS-wide functions like human capital management and procurement. In addition, obligations associated with IT are tracked separately from non-IT costs in IRS’s financial management system. For example, non-IT costs for merchant card and basis matching are tracked separately from the related Information Reporting and Document Matching (IRDM) IT system. Furthermore, organizational entities and other efforts of interest are not discrete. Obligations can be analyzed in different ways, such as from an organizational perspective or a program perspective. Different analyses should not necessarily be summed together because they may use different perspectives and, when considered together, might result in overlaps or gaps. For example, organizational entities and other efforts of interest have different perspectives where obligations may be counted towards either. For instance, obligations for the Wage and Investment fund center—an organizational entity—may overlap with related efforts of interest, such as identity theft. Users of IRS obligations data should be cognizant of these limitations.

Funding Streams for Obligations Data Vary in Complexity

IRS’s obligations data show how the elements of IRS’s budget formulation and budget execution structures described in figures 1 and 2 interact, and how those relationships vary in complexity. The data demonstrate the funding streams for IRS’s obligations: they show which appropriation accounts, budget activities, and program activities in IRS’s budget formulation structure received appropriated funds, as well as which fund centers within IRS’s budget execution structure managed and distributed the funds. Some fund centers in IRS’s budget execution structure receive appropriations from a relatively small number of appropriations accounts, budget activities, and program activities in IRS’s budget formulation structure. For example, as shown in figure 3, IRS obligated about $240 million from the Appeals fund center in fiscal year 2012. While most Appeals fund center resources come from the Appeals program activity, it also receives funding from other parts of IRS’s budget formulation structure, including funds from the International exams program activity.

Obligations data for organizational entities and other efforts of interest can also have a more complex relationship to IRS’s budget formulation structure than the Appeals example shown above. For example, in fiscal year 2012 the Wage and Investment fund center received funding from 3 of IRS’s 4 appropriations accounts, 5 of its 9 budget activities, and 23 of its 83 program activities (see figure 4). In addition, the ease with which IRS can compile obligations data varies: it can be more difficult for IRS to compile obligations data for programs with a more complex relationship to its budget formulation and budget execution structures.

New Budget Formulation Process Identifies Priorities and Reduces Some Work, but Guidance is Insufficient

For fiscal year 2014, IRS implemented a new, pre-selection budget formulation process to provide senior leadership with the opportunity to screen, prioritize, and select funding proposals before business units prepare detailed business cases. However, we found that in some instances the information was incomplete. Previously, business unit staff and subject matter specialists developed detailed business cases for each proposed initiative. Business cases include detailed narrative descriptions, multi-year cost estimates, and account breakouts. IRS budget officials told us the new process reduces work substantially for business units, since staff no longer need to develop extensive information for each proposal; instead, they only develop full information for proposals approved by senior leadership.

The new pre-selection process requires business unit staff to prepare selective, consistent information utilizing templates. (See appendix III for a sample template.) Templates include high level summary information on the purpose of the initiative, the amount of additional funds and FTEs requested, and the estimated impact of the initiative. Management reviews the templates and identifies a preliminary list of approved initiatives. Next, approved initiatives are communicated to business units via a decision document, along with any suggested changes in scope, such as combining initiatives or changing requested FTE or dollar levels. After preliminary approval, business unit staffs prepare detailed business cases for approved initiatives. process.

Business cases may ultimately be included in the budget request.

IRS Identified Potential Savings in Its Base Budget

The fiscal year 2014 budget request for IRS shows proposed savings and efficiencies in its base budget in several areas totaling over $217 million as shown in table 2. Some of IRS’s expected fiscal year 2014 savings are anticipated to be achieved through operational changes, such as shifting funds to automate processes and streamlining or consolidating operations and functions to make them more cost-effective.

IRS’s 2014 fiscal year budget includes the following savings and efficiencies:

Realizing Personnel Savings: Personnel savings are mainly the result of staff attrition and hiring restrictions.

Reducing IT Infrastructure: Examples of IT infrastructure changes include providing improved data storage capacity, updating computer servers to be more efficient, adopting common technology platforms and a more efficient telecommunications infrastructure, and changing IT contracting practices. For example, IRS is in the process of implementing virtual computer servers for data storage. Also, the IRS is implementing new technologies for sharing computer services across the agency.

Capturing Savings from Space Optimization: IRS has reduced (or plans to reduce) its office inventory, having selected 123 of its 648 offices to be closed, consolidated, or reduced. These rental savings are the result of attrition, hiring restrictions, and changes in working environments (such as increased telework and development of workspace standards that decrease individual office size). Space optimization savings require a one-time investment of $37.5 million to build out new and consolidated space and relocate employees, resulting in expected future rent savings of $76.7 million annually ($39.2 million net).

Funding BSM: BSM savings represent differences in projected costs of IT operations from one year to the next, including implementation costs related to the Current Customer Account Data Engine 2; Modernized e-File; Core Infrastructure; and Architecture, Integration, and Management. Implementing Human Capital Efficiencies: Administrative efficiency efforts include the consolidation of employment activities and modifications to training programs. For example, IRS reduced the number of Employment Hiring Centers from 9 to 3. IRS also streamlined processing of requests for personnel-related changes, such as salary increases, transfers, or leaves of absence. In addition, the Employment Operations Unit automated its hiring process to enable electronic completion of pre-hire forms. Some training programs are being modified from classroom training to webinars, reducing travel costs and allowing more employees to attend.

Achieving e-File Savings: These savings result from labor reductions related to increased use of electronic filing of tax returns and corresponding decrease in paper returns.

IRS Developed New Revenue Protection and Revenue Enhancement ROI Projections

In its fiscal year 2014 congressional justification, IRS included projected ROI for 10 enforcement initiatives, including two initiatives that used new approaches in estimating potential ROI: revenue protection and revenue enhancement. According to agency budget officials, IRS developed the new ROI methodologies because it did not have enough historical data on these initiatives to use the same methodology used for other initiatives. Since fiscal year 2008, IRS has included ROI projections for new revenue-generating enforcement initiatives in its congressional justification. IRS has generally calculated ROI projections for revenue generating initiatives based on the amount of additional tax collected. For each initiative, IRS calculated an estimate of the potential revenue collected by requested FTEs using 10 years of historical data. Because 10 years of historical data were not available for the revenue protection and revenue enhancement initiatives, IRS developed new methodologies.

For example, the fiscal year 2014 budget for IRS requests $101.1 million for an “Improve the Identification and Prevention of Refund Fraud and Identity Theft” initiative. According to IRS, if funded, the initiative would protect revenue because these activities would identify fraudulent returns related to identity theft and resolve cases prior to issuing a refund. To estimate the amount of projected revenue that would be protected, IRS determined the dollar amount of erroneous refunds detected per FTE from the beginning of the 2012 tax filing season through August of that year. As shown in figure 6, IRS estimated the ROI for this initiative to be 6.2 to 1 in fiscal year 2014, rising to 14.4 to 1 in fiscal year 2016.

The fiscal year 2014 budget for IRS also requests $51.7 million for a “Leverage Data to Improve Case Selection” initiative. According to IRS, if funded, this initiative would enhance revenue by improving technology that would enable IRS to improve case selection, issue identification, and enforcement case treatment. This technology would also allow IRS to adapt quickly to changing taxpayer behavior and tax code misuse. To estimate the additional amount of projected revenue that would be generated by this initiative, IRS studied the impact of using certain electronically filed data in a new way to examine selected tax returns and found that it could help classifiers detect more noncompliance. Based on the study’s findings, IRS estimated that using certain electronically filed data would increase examination assessments for taxpayers at all income levels, and used that estimate to calculate the amount of additional revenue that could be collected as a result of the “Leverage Data to Improve Case Selection” initiative. As shown in figure 7, IRS estimated an initial cost of $52 million in fiscal year 2014 followed by an estimated ROI of 1.3 to 1 in fiscal year 2015 and 1.5 to 1 in fiscal year 2016.

IRS Significantly Improved Its PPACA Cost Estimate, but Did Not Publicly Report Investment Information for the Fiscal Year 2014 Budget Request

Updated PPACA Cost Estimate Shows Significant Progress, but a Few Areas for Improvement Remain

In December 2012, IRS updated the PPACA cost estimate as part of its on-going practice to refine the cost estimate and address our prior recommendation. The updated cost estimate reflects best practices to a much greater extent, as shown in table 3. Unlike previous versions, the updated cost estimate shows significant progress, as it reflects the full- cycle cost of the program, which will total $1.89 billion from fiscal year 2010 through 2026. With this information, budget decision makers can see the amount IRS plans to spend on the multi-year PPACA effort in a particular year, as well as an estimate of costs that remain to be funded in future years. According to the GAO Cost Guide, a reliable cost estimate must be comprehensive, well documented, accurate, and credible. (See appendix IV for our full assessment of the updated PPACA cost estimate.) In June 2012, we reported that IRS’s cost estimate for PPACA did not fully meet best practices for a reliable cost estimate.

When enacted, PPACA contained 47 tax-related provisions that IRS is responsible for implementing with effective dates through 2018. Meeting these statutory requirements has required a significant IT investment in new data models, databases, and IT systems and operations support. IRS’s PPACA cost estimate is important in determining and communicating a realistic view of a program’s likely cost and schedule outcomes that can be used to plan the work necessary to develop, produce, install, and support the program. The cost estimate is also integral to establishing and defending budget requests: it provides context for the $440 million requested for IRS to address PPACA requirements in fiscal year 2014.

A few areas remain where IRS could continue to improve the reliability of the cost estimate to better meet best practices outlined in the GAO Cost Guide. We found that the cost estimate only partially met best practices for accuracy and credibility. Specifically, we identified three deficiencies in the accuracy of the cost estimate. First, the cost estimate was not fully adjusted for inflation. IRS adjusted future costs for inflation, and documented inflation rates, but reported past costs in current year dollars. Because sunk costs were not adjusted for inflation, their contribution to the cost estimate is higher than it should be. In August 2013, the IRS Chief Financial Officer told us that, as a result of this finding, IRS has already revised the next update to the PPACA cost estimate to adjust sunk costs for inflation. Second, IRS included actual sunk costs in the estimate, but it did not use earned value management—a process for capturing actual costs and comparing them to estimated costs. Earned value management would enable IRS to continuously update the estimate to reflect actual costs. Third, the estimate shows how it varies from a previous estimate, but it does not explain factors behind the variance. If the reasons for cost variances are not captured, estimators cannot identify lessons learned that would improve future estimates.

We also identified three deficiencies in the credibility of the cost estimate. First, IRS conducted a sensitivity analysis on two cost drivers (a sensitivity analysis examines the effects on changing assumptions and estimating procedures to highlight elements that are cost-sensitive). However, it is not clear how the two cost drivers were selected for analysis or whether IRS identified the cost elements that were the most sensitive to change. Second, IRS developed multiple risk management plans and conducted a risk and uncertainty analysis, but it is unclear how the risk management plans were applied to address the risks identified in the cost estimate. In addition, IRS incorrectly treated the total funding risk for the entire program as equal to the sum of the risks of individual elements. A proper risk and uncertainty analysis is necessary to correctly assess the variability in the cost estimate due to program risks. Third, IRS did not obtain a second cost estimate. The GAO Cost Guide specifies that producing two cost estimates that are independent of one another is a best practice because the second cost estimate can validate the first and provide an unbiased test of whether the original cost estimate is reasonable.

We discussed each of these deficiencies with IRS officials, who stated they gained a better understanding of the criteria in the GAO Cost Guide based on our meeting. Because it provides a sound basis for informed investment decision making, realistic budget formulation, and accountability for results, developing a reliable cost estimate that meets best practices is critical to PPACA’s success.

IRS Did Not Report PPACA Investment Information on the OMB Dashboard Website

Although the IT systems used to implement PPACA (which IRS refers to as the ACA IT investment) meet the Department of Treasury’s (Treasury) definition of a major investment, IRS reported the investment as a non- major investment in fiscal year 2014. According to agency officials, IRS did not have time to prepare the information that is typically reported for major investments in the President’s fiscal year 2014 budget request. Unlike major investments, non-major investments are not included for public reporting on the OMB IT Dashboard and are also not required to be included in the “Capital Asset Summary,” referred to as an Exhibit 300.

In prior years, IRS’s portion of the ACA IT investment was included with related investments that were managed and reported by the Department of Health and Human Services (HHS). HHS reported ACA IT investment information on the Dashboard. In January 2013, at the end of the fiscal year 2014 budget formulation cycle, IRS’s portion of the ACA IT investment was split from HHS’s portion and IRS assumed responsibility for reporting on its portion. The Clinger-Cohen Act of 1996 requires OMB to establish processes to analyze, track, and evaluate the risks and results of major capital investments in information systems and report to Congress on the net program performance benefits achieved as a result of these investments. In addition, OMB’s Capital Programming Guide defines major acquisitions to include capital assets that require special management attention because of high costs, high risk, or a significant role in the administration of agency programs. According to the Treasury budget director and IRS officials, the ACA IT investment is expected to be reported as a major investment in the fiscal year 2015 budget request. IRS and Treasury officials also told us they plan to include an Exhibit 300 and report ACA IT information on the OMB Dashboard.

Not reporting information on IRS’s ACA IT investment on the Dashboard or in an Exhibit 300 makes it more difficult to monitor and limits transparency. As a result, information about the implementation of PPAA—such as the individual projects that comprise the investment, evaluation history, current Exhibit 300 and cost and schedule variances— is not as readily available to Congress and the general public.

IRS Expanded Information Reported on Its Major IT Investments in the Fiscal Year 2014 Budget Justification, but Additional Information Would Be Useful

In the fiscal year 2014 budget justification, IRS included new, useful information on its major IT investments that was not included in prior budget justifications, such as life-cycle costs, projected useful life of the current asset, anticipated benefits, and how performance will be measured. This additional information is a significant enhancement to information provided in prior budget justifications, and provides decision makers with more context on IRS’s portfolio of IT investments. However, IRS does not provide information on IT investments in a consolidated format. IT is a significant portion—about 20 percent—of the total IRS budget request for fiscal year 2014. It includes approximately $2.6 billion to fund 18 major IT investments and 131 non-major investments. (See appendix V for a summary of the major IT investments.)

Redacted Exhibit 300s do not include sensitive data, such as estimated obligations for future budget years, names and contact information, and operational risks. in the Exhibit 300, such as the projected useful life of the current asset. However, certain other information (such as the start date, funds obligated through the prior fiscal year, and the number of FTEs represented by current costs) is only available in the Exhibit 300. Additional information (such as percent of life-cycle costs obligated through the prior fiscal year) is not available in either report, but can be calculated with information contained in the Exhibit 300 and budget justification. See table 4 for a general description of the type of information included in the budget justification and Exhibit 300.

Because different information exists in different documents, decision makers must access multiple public documents to gain a full understanding of IRS’s IT priorities. For example, if a decision maker was interested in the Modernized e-File (MeF) IT investment, the fiscal year 2014 budget justification would show that the projected useful life of the asset extends to 2019, however, to know the start date of the MeF investment—2001—the decision maker would also need to access the Exhibit 300. Likewise, the decision maker would see that the fiscal year 2014 budget justification shows the estimated life-cycle costs for MeF to be $575 million, however, to know how much has been obligated for the investment from the start date through fiscal year 2012—$304 million— the decision maker would have to access the Exhibit 300 and calculate the amount of funding obligated across prior fiscal years.

Consolidating key budget and performance information on major IT investments in one budget document (such as the congressional justification) would ensure decision makers have comprehensive, easy to understand information on major IT investments. In particular, consolidating information for complementary data elements (such as start date and projected useful life of the current asset, and amount of funding obligated through prior fiscal years and life-cycle costs) would provide useful context to understand IRS’s progress in implementing long-term IT investments. IRS officials said they can consolidate this information for ease of review.

GAO’s Standards for Internal Control in the Federal Government states that information should be communicated in a format that enables management and others to carry out their oversight responsibilities.

Further, the GPRA Modernization Act of 2010—which can serve as a guide to leading practices for planning at lower levels within federal agencies—requires that agencies consult with relevant committees when developing or making adjustments to their strategic plans and agency priority goals. Consulting with relevant committees regarding IT investments would provide IRS with an opportunity to share performance information and confirm that various committees are getting the types of performance information needed. Congressional staffs have requested comprehensive, easy to understand information on IRS’s IT investments: providing it in a comprehensive, consolidated format could provide them with better information to guide decisions. Congress directed IRS to include a summary of cost and schedule performance information for its major IT investments in its budget justification for fiscal year 2013; in addition, starting in March 2012, IRS was required to submit a report after every quarter with specific information on IRS’s selected major IT investments, including a “plain English” explanation of the cost and schedule for the previous three months and the cost and schedule performance for the upcoming three months. IRS has been submitting these reports and briefing the Appropriations Committees and other congressional stakeholders. Despite the increased information in the budget justification and the new quarterly report, key budget and performance information on all of IRS’s major IT investments remains in various budget documents. Until such data is consolidated, it is less accessible to congressional stakeholders.

IRS Implemented Six of Our Nine Prior Recommendations to Improve the Budget Presentation and Aid Decision Making

Since June 2012, IRS implemented six recommendations made in our prior reviews of its budget justification documents. Three of the implemented recommendations resulted in additional information in the budget request, such as actual ROI and linking funding requests for new initiatives to strategic goals and objectives. Enhanced information in the budget request can aid decision making and provide context to Congress regarding how current operations and requests for new funding support IRS priorities. Table 5 summarizes the recommendations implemented by IRS.

As shown in table 6, IRS officials agreed with two of the three budget related recommendations that remain open. IRS initially disagreed with our recommendation to modify its funding request for new hires. However, in August 2013, IRS Corporate Budget officials told us that IRS is considering options to implement the recommendation, including possibly describing in the operating plan how it plans to use available funds not needed for new hires in the first year.

Conclusions

IRS has taken important steps to include new and useful information in its budget justification to aid Congress and other stakeholders, including new information on actual ROI and enhanced information on major IT investments. In addition, IRS made significant improvements to the PPACA cost estimate, which is integral to accurately informing budget decision makers of the anticipated long-term costs for both implementation and administration of the new health care program. Furthermore, IRS’s new pre-selection process for determining which initiatives to request funding for was reported by officials to be a more efficient method for commencing budget formulation, although enhanced guidance could make it more effective. We also identified some other actions that could improve the budget request and aid Congress in decision making, including (1) improving the accuracy and credibility of the PPACA cost estimate in future updates because it provides the basis for informed investment decision making, realistic budget formulation, and accountability for results, (2) ensuring the ACA IT investment is publicly reported to increase transparency and (3) reporting consolidated information on major IT investments to make the information more accessible.

Recommendations for Executive Action

To enhance the budget process and to improve transparency, we recommend the Acting Commissioner of Internal Revenue take the following four actions: Improve guidance given to business units for the pre-selection budget formulation process, emphasizing the importance of information on the estimated impact—qualitative or quantitative—of proposed budget initiatives.

Improve the accuracy and credibility of future updates to the PPACA cost estimate by taking the following actions to more closely follow best practices outlined in the GAO Cost Guide:

Use earned value management to capture actual costs and use them as a basis for future updates.

Explain why variances occurred between the current estimate and previous estimates.

Document how cost drivers are selected for future sensitivity analyses.

Conduct future risk and uncertainty analyses consistent with best practices, and develop and document plans to address risks.

Validate the original cost estimate by preparing a second, independent cost estimate.

Publicly report the ACA IT investment as a major investment on the OMB IT Dashboard and the fiscal year 2015 budget request, including standard cost, schedule, and performance information.

Report key data on major IT investments in one consolidated document, such as the congressional justification, in consultation with congressional stakeholders.

Agency Comments and Our Evaluation

We provided a draft of this report to the Acting Commissioner of the IRS for his review and comment. We received an email on September 18, 2013 from the Chief Financial Officer, which included an attachment that provided the agency’s comments to our recommendations. This attachment is reprinted in appendix VI. In response to our draft report, the Chief Financial Officer stated that IRS agreed with three of our four recommendations and identified actions planned and taken to address them. For example, IRS agreed to include additional data on its major IT investments in the congressional justification, such as actual obligations for the investment to date. IRS agreed with the majority of the actions associated with our fourth recommendation on improving the accuracy and credibility of future updates of the PPACA cost estimate. IRS disagreed with two actions contained in our fourth recommendation. Specifically, IRS disagreed with our recommended action to use earned value management, a process that would enable IRS to continuously update the cost estimate to reflect actual costs. IRS stated that earned value management is not part of its current program management processes because the cost and burden to use earned value management outweigh the value added. We disagree with IRS’s view as to the benefits of earned value management. GAO has found that programs that establish good earned value management systems realize better project management decision making and fewer cost and schedule overruns. While there is an upfront investment to establish the earned value management system, there are long-term benefits that go beyond the individual project, such as fostering accountability, improving insight into program performance, and providing objective information for managing the program. Further, the OMB Capital Programming Guide states that earned value management is a critical component of risk management for major investments. IRS also disagreed with our recommended action to validate the PPACA cost estimate by preparing a second, independent cost estimate. IRS stated that the cost and burden of having an external organization produce a second, independent cost estimate of the same scope would outweigh the value added. In addition, IRS stated that an external organization would lack the knowledge necessary to produce a reasonable estimate without relying heavily on the IRS group that produced the first estimate. We disagree with IRS’s view. As reflected in the GAO Cost Guide, GAO has found that producing a second, independent cost estimate is considered one of the best and most reliable methods for validating a cost estimate. Without a second, independent cost estimate, decision makers lack insight into a program’s potential costs and may lack confidence that the estimate is reasonable and costs described in the first estimate can be achieved. While preparing a second cost estimate that is independent of the first cost estimate requires additional resources, it is generally based on the same detailed technical and procurement information. Furthermore, an independent cost estimate does not need to be conducted by an external organization, but the estimation team should be outside the acquisition chain and have nothing at stake with regard to program outcome or funding decisions. The major benefit of a second, independent cost estimate is that it provides an objective and unbiased assessment of whether the original estimate can be achieved; reducing the risk that the program will proceed underfunded or costs will exceed its value.

We plan to send copies of this report to the Chairman and Ranking Members of other Senate and House committees and subcommittees that have appropriation, authorization, and oversight responsibilities for IRS. We are also sending copies to the Acting Commissioner of Internal Revenue, the Secretary of the Treasury, and the Chairman of the IRS Oversight Board. Copies are also available at no charge on the GAO web site at http://www.gao.gov.

If you or your staffs have further questions or wish to discuss the material in this report further, please contact me at (202) 512-9110 or mctiguej@gao.gov. Contact points for our offices of Congressional Relations and Public Affairs may be found on the last page of this report. GAO staff who made major contributions to this report are listed in appendix VII.

Appendix I: Objectives, Scope, and Methodology

We were asked to review the President’s fiscal year 2014 budget request for the Internal Revenue Service (IRS). The objectives of this report were to (1) describe IRS’s capacity to report fiscal year 2012 obligations and full-time equivalent (FTE) data for program activities, organizational entities, and other efforts of interest; (2) assess IRS’s process and the type of information used to prioritize and select new program initiatives; (3) describe proposed base budget savings; (4) describe IRS’s new projected return on investment (ROI) methodologies; (5) evaluate steps IRS took to improve the cost estimate for the Patient Protection and Affordable Care Act (PPACA) in accordance with GAO’s Cost Estimating and Assessment Guide and determine the extent to which IRS is transparently reporting on the Affordable Care Act (ACA) information technology (IT) investment; (6) summarize IRS’s major IT investments and assess the type of information available in the congressional justification; and (7) describe IRS’s progress in implementing our prior budget-related recommendations.

To describe IRS’s capacity to report fiscal year 2012 obligations and FTE data, we reviewed documentation related to IRS budget formulation and budget execution, including IRS’s Financial Management Codes Handbook, IRS’s organizational chart, and its fiscal year 2014 congressional budget justification. We also interviewed knowledgeable officials in IRS’s Corporate Budget Office. We selected eight program activities, organizational entities, and efforts of interest for analysis: (1) Appeals, (2) Identity Theft, (3) International Exam and Collections, (4) Merchant Card and Basis Matching and the related Information Reporting and Document Matching (IRDM) IT system, (5) Offshore Voluntary Disclosure Program, (6) Online Services, (7) Telephone and Correspondence Services, and (8) Wage and Investment. We selected this list based on the following criteria: whether it was included in the proposed fiscal year 2014 budget initiatives, whether it was the topic of prior GAO work, and whether the selected list (as a whole) spans most of IRS’s appropriation accounts and encompasses a range of methods by which the data can be obtained from IRS’s financial management system. To determine IRS’s capacity to compile fiscal year 2012 obligations data for these eight items, we interviewed knowledgeable officials in IRS’s Corporate Budget Office. From the eight selected program activities, organizational entities, and other efforts of interest, we selected two illustrative examples to report fiscal year 2012 obligations data and to show how IRS’s budget formulation and budget execution structures interact: Appeals, and Wage and Investment. We selected these two examples largely to demonstrate the differences in structures. While they are both fund centers in IRS’s budget execution structure that manage and distribute funds, Appeals is also a program activity in IRS’s budget formulation structure and shows a relatively simple relationship between these structures. In contrast, Wage and Investment is a complex fund center that receives funding from many segments of IRS’s budget formulation structure. We assessed the reliability of IRS’s fiscal year 2012 obligations data by reviewing relevant IRS documents, including the Financial Management Codes Handbook, as well as prior work we conducted that assesses IRS’s financial statements. We believe that the data are sufficiently reliable for our purposes. We identified some limitations, but they do not affect our illustrative use of the data and are discussed in our report.

To assess IRS’s process and the type of information used to prioritize and select new program initiatives, we reviewed IRS documents related to its pre-selection budget formulation process for fiscal year 2014. Documents included guidance from the IRS Corporate Budget Office and pre- selection templates submitted for review by the taxpayer services and enforcement business units to senior leadership between November 2011 and May 2012. We analyzed these submissions for completeness against criteria for budget formulation outlined in OMB Circulars A-94. interviewed IRS officials familiar with the pre-selection process.

Office of Management and Budget, Revised, Guidelines and Discount Rates for Benefit- Cost Analysis for Federal Programs, OMB Circular No. A-94, (Revised October 1992). efficiencies, such as human capital, space optimization, and IT infrastructure summaries.

To describe IRS’s new projected ROI methodologies (of revenue protection and revenue enhancement) included in the fiscal year 2014 budget request, we discussed the difference between the new methodologies and IRS’s other projected ROI calculations with officials in IRS’s Office of Compliance Analytics and Corporate Budget Office. We also reviewed a related briefing developed by the Office of Compliance Analytics that summarizes the extent to which the use of non-transcribed electronic data impacts the classification of cases.

To evaluate steps IRS took to improve the PPACA cost estimate, we compared IRS’s updated PPACA cost estimate, completed in December 2012, with the characteristics of a high-quality cost estimate, identified in the GAO Cost Estimating and Assessment Guide (Cost Guide). Guide identifies four characteristics of a high quality cost estimate. The cost estimate should be (1) comprehensive, (2) well documented, (3) accurate, and (4) credible. We calculated the assessment rating of each criterion within the four characteristics by assigning each an individual assessment rating as follows: does not meet = 1, minimally meets = 2, partially meets = 3, substantially meets = 4, and meets = 5. We then averaged the individual practice scores to determine the overall rating. We shared our preliminary analysis of the updated PPACA cost estimate with program officials. When warranted, we updated our analyses based on the agency’s response and additional documentation provided to us.

See GAO, Cost Estimating and Assessment Guide: Best Practices for Developing and Managing Capital Program Costs (Supersedes GAO-07-1134SP), GAO-09-3SP (Washington, D.C.: Mar. 2, 2009). perform our assessment, we used relevant criteria on reporting capital investment information, including the Clinger-Cohen Act of 1996 and the OMB Capital Programming Guide.

To summarize IRS’s major IT investments (defined by Treasury as investments costing $10 million in either current year or budget year, or $50 million over the 5-year period extending from the prior year through the budget year +2) and to assess the type of information available in the congressional justification, we reviewed fiscal year 2013 and 2014 congressional budget justifications, Exhibit 300s—capital asset summaries—prepared by IRS for major IT investments, as well as IRS and OMB guidance on preparing those documents, such as the Office of Management and Budget Guidance on Exhibits 53 and 300—Information Technology and E-Government. We identified the type of information that is available across budget documents, in particular key information such as cost to date, full time equivalents, life-cycle costs, start date and end date.

To describe IRS’s progress in implementing our prior budget-related recommendations, we obtained information from various IRS officials and reviewed relevant documentation, including the fiscal year 2014 congressional budget justification and IRS’s Joint Audit Management Enterprise System (JAMES) reports, which track IRS actions taken to implement GAO recommendations. We then determined which recommendations were implemented.

We conducted our work in Washington, D.C., where key IRS officials involved with the budget and IT systems are located.

We conducted this performance audit from October 2012 to September 2013 in accordance with generally accepted government auditing standards. Those standards require that we plan and perform the audit to obtain sufficient, appropriate evidence to provide a reasonable basis for our findings and conclusions based on our audit objectives. We believe that the evidence obtained provides a reasonable basis for our findings and conclusions based on our audit objectives.

Appendix II: Non-Interactive Version of Figure 1: IRS’s Budget Formulation Structure

Budget activity Pre-filing taxpayer assistance and education

Filing and account services

Investigations

Exam and collections

Budget activity Regulatory

Infrastructure

Shared services and support

Budget activity Information services

Information technology investments

Appendix III: Figure 8: Pre-selection Budget Formulation Process—Sample Template

Appendix IV: Reliability of Patient Protection and Affordable Care Act Cost Estimate

Figures 9 through 12 outline our assessment of the extent to which IRS’s updated, December 2012 Patient Protection and Affordable Care Act (PPACA) cost estimate meets best practices. This information is repeated in table 7, following the graphics.

Appendix V: Summary of IRS’s Major Information Technology (IT) Investments

Total obligations through fiscal year2012 (in millions)

Lifecycle costs (in millions)

Total obligations through fiscal year2012 (in millions)

Lifecycle costs (in millions)

Total obligations through fiscal year2012 (in millions)

Lifecycle costs (in millions)

Lifecycle costs (in millions)

Total obligations through fiscal year2012 (in millions)

Appendix VI: Comments from the Internal Revenue Service

Appendix VII: GAO Contact and Staff Acknowledgments

GAO Contact

Staff Acknowledgments

In addition to the contact named above, Libby Mixon, Assistant Director; Remmie Arnold, Amy Bowser, Jennifer Echard, Emile Ettedgui, Mary Evans, Chuck Fox, Paul Middleton, Donna L. Miller, Edward Nannenhorn, Karen O’Conor, Sabine Paul, Laurel Plume, Karen Richey, Erinn L. Sauer, Cynthia Saunders, and Robert Yetvin made major contributions to this report.