IRS improved its 2006 filing season performance in important areas that affect large numbers of taxpayers. This continues a trend of improvement since at least 2002. Returns processing has gone smoothly and electronic filing continues to grow, although at a slower rate than in previous years. Taxpayer assistance has improved in the two most commonly used services—toll-free telephones and the Internet Web site. Fewer taxpayers visited IRS’s walk-in sites, and more sought assistance at volunteer-staffed sites. From January 1 through April 14, 2006, IRS processed 91.8 million individual income tax returns. Of those returns, 63.4 million returns were filed electronically (up 2.3 percent) and 28.3 million returns were filed on paper (down 7.1 percent). According to IRS data and officials, returns processing has gone smoothly so far this filing season. IRS issued 78 million refunds, 50 million, or 64 percent of which were directly deposited, up 5.4 percent over the same period as last year. Direct deposit is faster, more convenient for taxpayers, and less expensive for IRS than mailing paper checks. Because of the volume of tax returns, it is normal for IRS to experience some processing disruptions, although this year, disruptions have not been significant. For example, 13 different tax forms were unavailable for electronic filing until February 1 due to the late hurricane relief legislation, which caused a minor processing delay for some returns. Furthermore, IRS officials said that the new Customer Account Data Engine (CADE), which is intended eventually to replace IRS’s antiquated Master File system containing taxpayer records, processed over 6 million returns and dispersed 5.3 million refunds as of April 14, 2006 without disruptions. IRS is reporting that direct deposit refunds and paper check refunds are being issued within 4 and 6 business days, respectively, after tax returns are posted to CADE, which is faster than for returns processed by the Master File system. CADE’s growth in future years will directly benefit taxpayers. Not only can it speed up refunds, but it also updates taxpayer account information quicker than the Master File system. Representatives of the taxpayer industry corroborated IRS’s view that the filing season is going smoothly. Groups and organizations that we talked to included the National Association of Enrolled Agents, the American Institute of Certified Public Accountants, and others. In addition, the TIGTA recently testified that thus far it has seen no significant problems during the filing season. The growth of electronic filing is important, because it generates savings by reducing staff years needed for labor intensive paper processing. Between fiscal years 1999 and 2006, IRS reduced the number of staff years devoted to paper and electronic processing by 1,586, or 34 percent as shown in figure 1. Electronic filing continues to grow but at a slower rate than previous years. This year’s 2.1 percent rate of growth is less than the average annual rate of growth of 5.1 percent for each of the preceding 2 years. According to IRS officials, the slower growth in electronic filing this year is due, in part, to changes in the Free File program, which reduced the number of taxpayers eligible to file electronically for free this year and reduced publicity and advertising by companies involved in that program, and the termination of the TeleFile program, which eliminated the way for taxpayers to file their returns electronically via telephone. The Free File program enables taxpayers to file their returns electronically via IRS’s Web site. Through IRS’s Web site, taxpayers can access the Web sites of 20 companies comprising the Free File Alliance. The alliance is a consortium of tax preparation companies that agreed to offer free return preparation and electronic filing for taxpayers that meet certain criteria (see app. 1 for further detail). In an amended agreement with IRS that took effect this year, the Free File Alliance set a $50,000 income limitation on taxpayer participation. This limit was absent last year and reduced the number of taxpayers eligible to participate in the program. As of April 13, 2006, IRS processed about 3.5 million free file returns, which is a decrease of 24 percent from the same period last year. This decline is inconsistent with IRS’s projection that it would receive 6 million tax returns filed through the Free File program, almost a million more compared to last year. For 2006, IRS terminated the TeleFile program. IRS expected that eliminating TeleFile would reduce electronic filing, but justified the decision because of declining usage and relatively high costs. The number of taxpayers using the program had been decreasing—from approximately 5.7 million in 1999 to 3.8 million in 2004. IRS estimated the cost per tax return submitted through TeleFile, typically Form 1040EZ, to have been $2.63 versus $1.51 for a return filed on paper, largely due to contractor, telecommunications, and other costs. Given the limitations of IRS’s cost accounting system, the validity of these figures is unknown. IRS officials stated that the reason for this year’s increase in the number of 1040EZ returns filed on paper is due, in part, to the elimination of TeleFile. Through April 14, 2006, the number of 1040EZ returns filed on paper has increased 20 percent from last year. Options for increasing electronic filing, in particular mandated electronic filing, will be discussed in the budget section of this statement. Taxpayers’ ability to access IRS’s telephone assistors and the accuracy of answers provided improved compared to previous years. From January 1 through April 15, 2006, IRS answered approximately 31 million phone calls, which is about a 7 percent decline from the same period last year. The call volume has been less than projected by IRS and less than was assumed when IRS set staffing levels for telephone assistors for the filing season. IRS officials offered several explanations for the unexpected decline in call volume. One explanation is that more taxpayers are using improved tax preparation software, which reduces their need to call IRS. Another explanation is that more taxpayers are getting through to a telephone assistor the first time they call, thus reducing the need for taxpayers to call again. As shown in table 1, the percentage of taxpayers who attempted to reach an assistor and actually got through and received service—referred to as the level of service—is 83.3 percent so far this filing season compared to 81.7 percent over the same period last year—and greater than its 2006 fiscal year goal of 82 percent. According to IRS officials, one possible explanation for the improvement in access is the decline in overall call volume. When call volume decreases, taxpayers are likely to wait less time to speak with an IRS telephone assistor. As a result, fewer taxpayers would likely hang up, increasing the percentage of taxpayers who get through to an assistor. IRS also reported that, so far this filing season, the average speed of answer (length of time taxpayers wait to get their calls answered) is down 51 seconds from the same time last year to 205 seconds, a decrease of about 20 percent, and significantly better than IRS’s 2006 fiscal year goal of 300 seconds. IRS also reported that the rate at which taxpayers abandoned their calls to IRS decreased from 12 percent to 9.7 percent compared to the same period last year. Using a statistical sampling process, IRS estimates that the accuracy of telephone assistors’ responses to taxpayers’ tax law and account questions improved compared to last year. IRS estimates its tax law accuracy rate to be 90 percent, an increase of 1.9 percentage points over the same time period last year, continuing an improvement since 2004. Additionally, IRS estimates that the accuracy rate to taxpayers’ inquiries about their accounts, to be 92.9 percent this year compared to 91.6 percent over the same period last year, continuing an improvement since 2003. IRS officials attribute these improvements in performance to several factors, including better and more timely performance feedback for telephone assistors, increased assistor experience, better training, and increased use of the Probe and Response Guide, a script used by telephone assistors to understand and respond to tax law questions. Use of IRS’s Web site has increased so far this filing season compared to prior years based on the number of visits and downloads. From January 1 through March 31, IRS’s Web site was visited 95 million times by visitors who downloaded 90 million forms and publications. The number of visits reflects a 7.5 percent increase over the same period last year while the number of forms and publications downloaded has increased by 34 percent. Further, IRS’s Web site is performing well. For example, we found IRS’s Web site to be readily accessible, easy to navigate, and an independent weekly study by Keynote, a company that evaluates Web sites, reported that IRS’s Web site has repeatedly ranked second out of 40 government agencies evaluated in terms of average download time. The same study also reported that IRS has repeatedly ranked first out of the most commonly accessed government related Web sites for response time and success rate, and the American Consumer Satisfaction Index overall customer satisfaction with IRS’s Web site increased from 68 to 72 percent after IRS reconfigured the site. IRS reconfigured its Web site for the 2006 filing season. According to IRS officials, the goal for reconfiguring the Web site was to improve overall customer service through easier navigation and a more effective search function. As a result, the number of Web site searches has decreased by 51 percent, from 108 million during the same period last year to 52.5 million this year. Typically, search functions are used when users fail to find information through links. According to IRS officials, the decrease in the number of searches indicates that users are finding the information that they need faster. IRS also added the following new features to its Web site this year: Electronic IRS: The Electronic IRS brand reconfigured the IRS’s Web site and made it easier to locate items, as evidenced by the decline in searches; Alternative Minimum Tax (AMT) Assistant: Helps taxpayers determine if they do not owe AMT; and Help for Hurricane Victims: A special link that provides victims of the recent hurricanes information on special tax relief, assistance and how to get help with tax matters. IRS’s Web site continues to include several important features in addition to the Free File program: Where’s My Refund, which allows taxpayers to check on the status of their refunds. As of April 15, 2006, 24 million taxpayers accessed the Where’s My Refund feature to check on the status of their tax refunds. This was a 17 percent increase from the same period last year; and Electronic Tax Law Assistance, where taxpayers can ask IRS general tax law questions via its Web site. From January 1 through April 14, 2006, IRS received 10,160 emails requesting tax law assistance (down over 43 percent compared to last year). As of March 31, 2006, IRS estimated the accuracy rate of IRS’s responses to tax law questions submitted via the Web site, to be 85 percent, similar to 2005. However, the average number of days that it took IRS to respond to tax law questions submitted via the Web site was 2.2 days, compared to 1.2 days in 2005. Fewer taxpayers have used IRS’s 400 walk-in sites so far in the 2006 filing season compared to the same period in prior years. Staff at walk-in sites provide taxpayers with information about their tax accounts and answer taxpayers’ questions within a limited scope of designated tax law topics, such as those related to income, filing status, exemptions, deductions, and related credits. Walk-in site staffs also provide need-based tax return preparation assistance, limited to taxpayers meeting certain requirements. As of April 1, 2006, the total number of contacts at IRS’s walk-in sites declined by approximately 12 percent compared to last year. The decline thus far this year is consistent with the annual trends in walk- in use shown in figure 2, including IRS’s projection for 2006. The declines in the number of taxpayers using IRS’s walk-in sites, including for tax return preparation, are also consistent with IRS’s strategy to reduce its costly face-to-face assistance by providing taxpayers with additional options, such as IRS’s toll-free telephone service, Web site, and numerous volunteer sites. It is unclear, however, whether the declining volume is an indicator of how well IRS is meeting taxpayers’ demand for face-to-face assistance. For example, IRS does keep track of the number of taxpayers entering a walk-in site, taking a number to queue for service, but then leaving the site without receiving service. If a taxpayer did not take a number, IRS would have no way of counting those taxpayers. IRS officials said the types of services offered at walk-in sites remained constant for most sites from 2005 to 2006. For sites in areas with a high number of natural disaster victims, IRS expanded the types of assistance provided. For example, IRS adjusted the type of tax law questions that it would answer at walk-in sites to include casualty loss and removed income limitations for disaster victims seeking return preparation assistance at walk-in sites. In contrast to IRS walk-in sites, the number of taxpayers seeking return preparation assistance at approximately 14,000 volunteer sites has increased this year by 8.7 percent, continuing the trend since 2001 (see fig. 2). These sites, often run by community-based organizations and staffed by volunteers who are trained and certified by IRS, do not offer the range of services IRS provides at walk-in sites, but instead focus on preparing tax returns primarily for low-income and elderly taxpayers and operate chiefly during the filing season. As we have previously reported, the shift of taxpayers from walk-in to volunteer sites is important because it has allowed IRS to transfer time-consuming services, such as return preparation, from IRS to other less costly alternatives that can be more convenient for taxpayers. IRS has used both walk-in and volunteer sites to provide relief efforts for federally-designated disaster zones such as in hurricane-affected areas. IRS developed a Disaster Referral Services Guide and new training materials for employees to better equip them to address disaster-related issues. In addition to the expanded services for disaster victims at IRS walk-in sites noted above, volunteer sites performed outreach within their network of partners by creating training material for tax preparers, and agreeing with two organizations to accept referrals from IRS of disaster victims needing tax return preparation assistance. IRS continues to lack reliable data on the quality of the services provided at walk-in and volunteer sites. As in previous years, TIGTA is conducting an audit on the accuracy of some services provided at walk-in sites, although the results will not be available until after the filing season. However, TIGTA has noted problems with the quality of services provided at IRS walk-in sites in prior reports. We have made recommendations for IRS to improve its quality measurement at walk-in sites. At volunteer sites, IRS is conducting different types of reviews to monitor tax return preparation assistance. According to IRS officials, the results to date show that the quality of service has improved at volunteer sites compared to previous years, but they acknowledge that challenges remain in terms of volunteers’ adherence to IRS’s procedures and use of IRS materials. As in previous years, TIGTA will conduct limited quality reviews at volunteer sites. While the results of those reviews are based on a judgmental sample, TIGTA has concluded in the past that, while significant improvements have been made in the oversight of volunteer sites, continued effort is needed to ensure the accuracy of tax return assistance provided. In addition to service from IRS, millions of taxpayers receive service, such as tax return preparation, from paid preparers. About 56 percent of about 130 million individual tax returns filed for tax year 2002 used a paid tax preparer, with higher paid preparer usage among taxpayers with more complicated returns. We recently reported, however, that some preparers make serious errors when completing returns. Based on our very limited sample of 19 paid tax preparers, taxpayers who rely on tax preparers to provide them with accurate, complete, and fully compliant tax returns may not get what they pay for. For example, during visits to paid preparers, tax returns prepared for GAO often varied widely from what we determined the returns should and should not include, sometimes with significant consequences. Their work resulted in unwarranted extra refunds of up to almost $2,000 in 5 instances, while in 2 cases they cost the taxpayer over $1,500. Some of the most serious problems involved paid preparers: not reporting business income in 10 of 19 cases; not asking about where a child lived or ignoring GAO’s answer to the question therefore allowing an ineligible child to be claimed for the Earned Income Tax Credit in 5 out of the 10 applicable cases; failing to take the most advantageous postsecondary education tax benefit in 3 out of the 9 applicable cases; and failing to itemize deductions at all or failing to claim all available deductions in 7 out of the 9 applicable cases. Many of the problems we identified put paid preparers, taxpayers, or both at risk of IRS enforcement actions. According to IRS officials, paid preparers and taxpayers risk enforcement action by filing a tax return that includes the types of misstatements or omissions we reported. According to the officials, if IRS were to uncover problems with the preparation of real tax returns similar to several that we found, the preparers would be subject to civil sanctions. If an erroneous return was prepared, in addition to paying the correct tax due and any related late payment interest, the taxpayer may also be assessed a penalty, depending on the facts and circumstances of each situation, according to IRS officials. For example, if taxpayers substantially understate income, overstate deductions, or provide other incorrect information resulting in decreased tax or improperly high refunds, they may be assessed an accuracy-related penalty. The penalty could be assessed for any failure to comply with the tax laws, including the failure to report self-employment income (further discussion on the consequences of the errors of paid tax preparers is provided in the discussion on the tax gap). IRS’s fiscal year 2007 budget request is a small decrease compared to 2006 enacted levels after adjusting for expected inflation. It proposes to reduce overall staffing levels, as well as staffing levels for taxpayer service and enforcement activities, while maintaining or improving taxpayer service and enforcement. As it has in prior years, IRS has identified some savings, but additional opportunities exist for enhancing savings. IRS’s proposed fiscal year 2007 budget is $11 billion (a 1.6 percent increase), but after adjusting for expected inflation, it reflects a slight decrease over last year’s enacted budget. The $11 billion includes $417 million from new and existing user fees and reimbursable agreements with other federal agencies. The 2007 budget request for IRS’s appropriation accounts is shown in table 2 (see app. II for more details). The real decrease in the proposed budget can be seen in staffing. IRS proposes to fund 95,476 FTEs in fiscal year 2007, down over 2 percent from 97,754 FTEs in enacted fiscal year 2006 (see table 5 in app. II for comparisons in enacted FTE levels for fiscal years 2002 through 2007). Actual FTEs tend to be lower than enacted FTEs, in part, because of how IRS absorbs unbudgeted costs (see table 6 in app. II for actual FTEs). The decrease in FTEs may be greater than shown in IRS’s fiscal year 2007 budget request. Every year agencies, including IRS, are expected to absorb some costs that are not included in their budget requests. For fiscal year 2007, IRS officials currently anticipate having to absorb over $117 million in costs, including about $41 million for homeland security-related controls over physical access to government facilities. Absorbing such costs reduces the actual number of FTEs that IRS can support. For example, for fiscal year 2005, the enacted level of FTEs was 96,435 but the actual level was 94,282. IRS is requesting $4.2 billion for PAM, including some user fees, which is funding primarily spent on providing service to taxpayers. The amount requested is about a 1.6 percent increase over fiscal year 2006 enacted levels, but is a slight decrease after adjusting for expected inflation. This funding level translates into reduced staffing, down over 4 percent from an enacted level of 38,796 FTEs in fiscal year 2006 to 37,126 proposed FTEs in fiscal year 2007. Since fiscal year 2002, FTEs devoted to PAM have declined over 15 percent from an enacted level of 43,866 FTEs. Despite the proposed inflation-adjusted decrease in funding in 2007, IRS is planning to maintain or improve taxpayer services. For every one of the major taxpayer services listed in the budget, 2007 planned performance goals are higher or equal to 2006 performance goals. These services include telephone assistance and refund issuance. IRS is requesting $4.8 billion for TLE. The 2007 budget request proposes an overall decrease in enforcement FTEs, down over 2 percent to a proposed 49,479 FTEs from last year’s enacted level of 50,559 FTEs. For its three main categories of skilled enforcement staff, IRS is proposing a marginal increase in staffing of 0.2 percent (see fig. 3). For special agents (those who perform criminal investigations), the increase is 1.7 percent. For the other two categories—revenue agents (those who examine complex returns), revenue officers (those who perform field collection work)—IRS is proposing to keep the number of staff the same as in 2006. Despite keeping skilled enforcement staff virtually unchanged, IRS is proposing to maintain or increase its major enforcement activities. For all the major enforcement activities listed in the budget, IRS is establishing goals in 2007 that are higher or equal to 2006 planned performance goals. Major enforcement activities include individual taxpayer examinations, collection coverage, and criminal investigations completed. IRS officials anticipate increased revenue collected and other performance improvements as a result of using data from IRS’s most current compliance research effort, known as the National Research Program (NRP). IRS is requesting about $1.6 billion for IS in fiscal year 2007, which is intended to fund information technology (IT) staff and related costs for activities such as information security and maintenance and operations of its current tax administration systems. Although the number of FTEs proposed in 2007 is up when enacted FTEs are considered, it is virtually the same as the operating level currently assumed in 2006 (see app. II for more details). In 2002, we reported that the agency did not develop its fiscal year 2003 IS operations and maintenance budget 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 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. In August 2005, IRS issued the initial version of its IT Capital Planning and Investment Control (CPIC) Process Guide, which (1) provides executives with the framework within which to select, control, evaluate, and maintain the portfolio of IT investments to best meet IRS business goals and (2) defines the governance process that integrates the agency’s IT investments with the strategic planning, budgeting, and procurement processes. According to IRS officials and documentation, the agency formulated its prioritized fiscal year 2007 IT portfolio and associated budget request, including operations and maintenance requirements, in accordance with this CPIC Process Guide. We will continue to monitor the implementation of IRS’s CPIC process as its IT investment management process matures. In addition, IRS stated that it planned to develop an activity-based cost module to plan, project, and report costs for business tasks/activities funded by the IS budget. During fiscal year 2005, as part of the first release of the Integrated Financial System (IFS), IRS implemented a cost module that is potentially capable of allocating costs by activity. However, agency officials stated that they needed to accumulate 3 years of actual costs to have the historical cost data necessary to provide a basis for meaningful future budget estimates. Since then, according to the Office of the Chief Financial Officer, IRS has (1) populated the cost module with all actual fiscal year 2005 expenses; (2) identified the data needed from IFS to support its budget requests; and (3) developed a system to capture, test, and analyze the cost data to devise a standard methodology to provide the necessary data from the cost module. IRS still expects to have the requisite 3 years of historical cost data available in time to support development of the fiscal year 2010 budget request. Although IRS has made progress in implementing best practices in developing its IS operations and maintenance budget, until IRS completes the actions necessary to fully implement the activity–based cost module, the agency will not be able to ensure that its request is adequately supported. BSM is a high-risk, highly complex effort that involves developing and delivering a new set of information systems that are intended to replace the agency’s aging tax processing and business systems. The program 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. It also helps IRS considerably in providing the reliable and timely financial management information needed to account for the nation’s largest revenue stream and better enable the agency to both determine and justify its resource allocation decisions and budget requests. IRS’s fiscal year 2007 budget request of $167.3 million for the BSM program reflects a reduction of about 15 percent (and even greater when adjusted for expected inflation), or about $30 million, from the enacted fiscal year 2006 budget of $197 million. Over the past year, IRS has made further progress in implementing BSM, although some key projects did not meet short-term cost and schedule commitments. During 2005 and the beginning of 2006, IRS deployed additional releases of several modernized systems that have delivered benefits to taxpayers and the agency, including CADE, e-Services (a new Web portal and electronic services for paid tax preparers), and Modernized e-File (a new electronic filing system). While three BSM project releases were delivered within the cost and/or schedule commitments presented in the fiscal year 2005 expenditure plan, others experienced cost increases or schedule delays. For example, two IFS and Modernized e-File project release segments experienced cost increases of 93 percent and 29 percent, respectively. As we have previously reported, the BSM program has had a history of cost increases and schedule delays that have been due, at least in part, to deficiencies in various management controls and capabilities that have not yet been fully corrected. IRS is in the process of implementing our prior recommendations to correct these deficiencies. IRS has identified significant risks and issues that confront future planned system deliveries. For example, according to IRS, schedule delays and contention for key resources between multiple releases of CADE necessitated the deferral of some functionality. This deferral, in conjunction with additional recently reported risks and issues, may negatively impact the cost, schedule, and functionality for future CADE releases. The agency recognizes the potential impact of these project risks and has developed mitigation strategies to address them. We will, however, continue to monitor the various risks IRS identifies and the agency’s strategies to address them and will report any concerns. IRS also has made additional progress in addressing high-priority BSM program improvement initiatives during the past year, including initiatives related to shifting the role of systems integrator from the prime contractor to IRS and establishing requirements management standards—an initiative on which we recently issued a report to you, Mr. Chairman, and made a number of recommendations for improvement. IRS’s program improvement process appears to be an effective means of assessing, prioritizing, and addressing BSM issues and challenges. However, much more work remains for the agency to fully address these issues and challenges. In addition, in response to our prior recommendation, IRS is developing a new Modernization Vision and Strategy to address BSM program changes and provide a modernization roadmap. According to the Associate Chief Information Officer for BSM, the agency’s new strategy focuses on promoting investments that provide value in smaller, incremental releases that are delivered more frequently, with the goal of increasing business value. IRS is currently finalizing a high-level vision and strategy as well as a more detailed 5-year plan for the BSM program. We believe these actions represent sound steps toward addressing our prior recommendation to fully revisit the vision and strategy and develop a new set of long-term goals, strategies, and plans consistent with the budgetary outlook and with IRS’s management capabilities. Further, this strategy is important because it will describe how and when IRS will receive the full benefits from its modernization efforts, such as when CADE will be able to replace the Individual Master File. While the requested fiscal year 2007 BSM budget will allow IRS to continue the development and deployment of the CADE, Modernized e- File, and Filing and Payment Compliance (F&PC) projects, the proposed reduced funding level would likely affect the agency’s ability to deliver the functionality planned for the fiscal year and could result in project delays and/or scope reductions. This could, in turn, impact the long-term pace and cost of modernizing tax systems and of ultimately improving taxpayer service and strengthening enforcement. For example, according to IRS documents, the agency had planned to spend $85 million in fiscal year 2007 to develop and deploy additional CADE releases that would enable the system to process up to 50 million individual tax returns by the 2008 filing season and issue associated refunds faster. However, with a proposed budget of $58.5 million—over 30 percent less than anticipated— IRS would likely have to scale back its planned near-term work on this project. In addition, the reductions to the planned budgets for the Modernized e-File and F&PC projects may also result in IRS having to redefine the scope and/or reassess schedule commitments for future project releases. The proposed BSM budget reduction would also significantly reduce the amount allotted to program management reserve by about 82 percent (from $13 million in fiscal year 2006 to $2.3 million in fiscal year 2007). If BSM projects have future cost overruns that cannot be covered by the depleted reserve, this reduction could result in increased budget requests in future years or delays in planned future activities. While the BSM program still faces challenges, IRS has recently made progress in delivering benefits and addressing project and program-level risks and issues. Reducing BSM funds at a time when benefits to taxpayers and the agency are being delivered could adversely impact the momentum gained from recent progress and result in delays in the delivery of future benefits. However, until IRS addresses our prior recommendation by clearly defining its future goals for the BSM program as well as the impact of various funding scenarios on meeting these goals in its new Modernization Vision and Strategy, the long-term impact of the proposed budget reduction is unclear. In its 2007 budget request, IRS identified savings as it has done in prior years and plans to redirect some of those savings to front-line taxpayer service and enforcement activities. IRS is proposing to save over $121 million and 1,424 FTEs by, for example, automating the process of providing an individual taxpayer identification number to those taxpayers ineligible for a Social Security number and improving data collection techniques and work processes for enforcement activities through increased financial reporting requirements and scanning and imaging techniques. IRS’s history of realizing savings proposed in past budget requests provides some confidence that the agency will be able to achieve savings in fiscal year 2007. For example, IRS reported it realized 88 percent of the anticipated dollar savings and 86 percent of the anticipated staff savings identified in the fiscal year 2004 budget request. IRS also reported exceeding the savings targets in the fiscal year 2005 budget request (see app. III). In addition to the areas identified by IRS in its budget request, there may be additional opportunities for efficiency gains. Increasing electronic filing: In an era of tight budgets, continued growth in electronic filing may be necessary to help fund future performance improvements. One proposal for continuing to increase electronic filing is additional use of electronic filing mandates. Currently, IRS mandates electronic filing for large corporations. The 2007 budget request proposes a legislative change that would expand its authority to require electronic filing for businesses. Moreover, 12 states now mandate electronic filing for certain classes of tax preparers (see app. IV for more information on state mandates). As we have reported, although there are costs and burdens likely to be associated with electronic filing mandates for paid tax preparers and taxpayers, state mandates have generated significant increases in electronic filing. IRS has an electronic filing strategy, which the agency is updating. Changing the menu of taxpayer services: IRS currently lacks a comprehensive strategy explaining how its various taxpayer services (including its telephone, walk-in, volunteer, and Web site assistance) will collectively meet taxpayer needs. In response to a Congressional directive, IRS is developing such a strategy. The strategy is important because some taxpayers may not be well served by the current service offerings. IRS’s attempts to reduce some taxpayer services, namely reducing the hours of telephone operations and closing some walk-in sites, have met with resistance from the Congress. Although congressional directives to study the impact of IRS’s actions exist, we still believe there may be opportunities to adjust IRS’s menu of services to reduce costs, without affecting IRS’s ability to meet taxpayers’ needs. Consolidating telephone call sites: IRS operates 25 call sites throughout the country. Consistent with earlier plans, IRS closed two of its smallest call sites—Chicago and Houston—in March 2006, to realize savings in its toll-free telephone operations. Also, IRS has gained efficiencies from using a centralized call router located in Atlanta. As a result, there are currently more than 850 workstations that are not being used; consequently, IRS may have the potential to close several additional call sites. Consolidations would not affect telephone service and would be invisible from the taxpayer’s perspective. Managing a federal agency as large and complex as IRS requires managers to constantly weigh the relative costs and benefits of different approaches to achieving the goals mandated by the Congress. Management is constantly called upon to make important long-term strategic as well as daily operational decisions about how to make the most effective use of the limited resources at its disposal. As constraints on available resources increase, these decisions become correspondingly more challenging and important. In order to rise to this challenge, management needs to have current and accurate information upon which to base its decisions, and to enable it to monitor the effectiveness of actions taken over time so that appropriate adjustments can be made as conditions change. In its ongoing effort to make such increasingly difficult resource allocation decisions and defend those decisions before the Congress, IRS has long been hampered by a lack of current and accurate information concerning the costs of the various options being considered. Instead, management often has relied on a combination of the limited existing cost information; the results of special analysis initiated to establish the full cost of a specific, narrowly defined task or item; and estimates based on the best judgment of experienced staff. This has impaired IRS’s ability to properly decide which, if any, of the options at hand are worth the cost relative to the expected benefits. For example, accurate and timely cost information may help IRS consider changes in the menu of taxpayer services that it provides by identifying and assessing the relative costs, benefits, and risks of specific projects. Without reliable cost information, IRS’s ability to make such difficult choices in an informed manner is seriously impaired and IRS cannot prepare cost-based performance measures to assist in measuring the effectiveness of its programs over time. Further, IRS does not have the capability to develop reliable information on the return on investment for each category of taxpayer service and enforcement. IRS lacks reliable information on both the return from services (the additional revenue collected by helping taxpayers understand their tax obligations) and the investment or cost of the services. While developing return on investment information is difficult, the cost component of that equation may be the least complex to develop. Having such cost information is a building block for developing return on investment estimates. For its enforcement programs, IRS has developed a rough measure of return on investment in terms of tax revenue that is directly assessed from uncovering noncompliance. Continuing to develop return on investment measures could help officials make more informed decisions about allocating resources. Even without return on investment information, cost information can help IRS determine if, for example, IRS should change the menu of services provided. As discussed in the BSM section, in fiscal year 2005, IRS implemented a cost accounting module as part of IFS. However, while this module has much potential and has begun accumulating cost information, IRS has not yet determined what the full range of its cost information needs are or how best to tailor the capabilities of this module to serve those needs. Also, IRS does not have an integrated workload management system which would provide the cost module with detailed allocation of personnel cost information. In addition, as noted in developing its IS budget, because it generally takes several years of historical cost information to support meaningful estimates and projections, IRS cannot yet rely on IFS as a significant planning tool. It will likely require several years, implementation of additional components of IFS, and integration of IFS with IRS’s tax administration activities before the full potential of IFS’s cost accounting module will be realized. Furthermore, IRS’s fiscal year 2007 BSM budget request does not include funding for additional releases of IFS. In the interim, IRS decision making will continue to be hampered by inadequate underlying cost information. For the first time, IRS’s budget request sets long-term goals aimed at reducing the tax gap, although IRS does not have a data-based plan for achieving the goals. However, because of its persistence, reducing the tax gap requires solutions which go beyond funding and staffing for IRS. IRS established two agencywide, long-term performance goals, as shown in table 3. IRS plans to improve voluntary compliance from 83 percent in 2005 to 85 percent by 2009, and reduce the number of taxpayers who think it is acceptable to cheat on their taxes from 10 percent in 2005 to less than 9 percent in 2010. According to IRS, these are the first in a series of quantitative goals that will link to its three strategic goals—improve taxpayer service, enhance tax law enforcement, and modernize IRS through technology and processes. These goals will be challenging to meet, because for three decades, IRS has consistently reported a persistent, relatively stable tax gap. Although IRS has made a number of changes in its methodologies for measuring the tax gap, which makes comparisons difficult, regardless of methodology used, the voluntary compliance rate that underpins the gap has tended to range from around 81 percent to around 84 percent. Because of a lack of quantitative estimates of how changes to its service and enforcement programs affect compliance, IRS is unable to show in a data-based plan how it will use those programs to reach the two long-term goals shown in table 3. If IRS could quantify the impact of its service and enforcement programs on the compliance rate or attitudes towards cheating, it could use the information to show the kinds of changes to the programs needed to achieve the long-term goals and how best to direct resources towards achieving those goals. Unfortunately, quantifying the impact of IRS’s service and enforcement programs on compliance or cheating is very challenging. The type of data needed to make such a link does not currently exist, and may not be easy to collect. Lacking such quantitative estimates, IRS must take a more qualitative approach in its plans for increasing compliance, which would likely also involve changing attitudes towards cheating. IRS’s overall approach to reducing the tax gap consists of improving service to taxpayers and enhancing enforcement of the tax laws. We recently reported that IRS has taken a number of steps that may improve its ability to reduce the tax gap. Favorable trends in staffing of IRS enforcement personnel; examinations performed through correspondence, as opposed to more complex face-to-face examinations; and the use of some enforcement sanctions such as liens and levies are encouraging. Also, IRS has made progress with respect to abusive tax shelters through a number of initiatives and recent settlement offers that have resulted in billions of dollars in collected taxes, interest, and penalties. Finally, IRS has continually improved taxpayer service by increasing, for example, the accuracy of responses to tax law questions. The effect of this overall approach and the 2007 budget proposal will have on voluntary compliance has not been quantified by IRS. Therefore, the Congress will have to rely on the IRS Commissioner for qualitative explanations, of why, in his judgment, IRS’s mix of taxpayer service and enforcement and overall approach for reducing the tax gap, including the 2007 budget proposal, will be sufficient to start IRS on a path towards achieving its long-term goals. More specifically, such explanations could include a clear statement of which service and enforcement programs have priorities for expansion because they are expected to contribute the most to increasing the compliance rate and the evidence that supports that judgment. In addition, IRS lacks a plan for measuring progress towards one goal— improving voluntary compliance. IRS plans to measure progress towards the second goal—reducing the percentage of taxpayers who think it is acceptable to cheat—via the IRS Oversight Board’s annual Taxpayer Attitude Survey. Nevertheless, IRS recently estimated voluntary compliance as part of the NRP study, which reviewed the compliance of a random sample of individual taxpayers and used those results to estimate compliance for the population of all taxpayers. The study took several years to plan and execute. In addition to providing an estimate of the compliance rate, the study’s results will be used to better target IRS’s audits of potentially non- compliant taxpayers. Better targeting reduces the burden on taxpayers because IRS is better able to avoid auditing compliant taxpayers. At this time, however, IRS has not made plans to repeat the study in time to measure compliance by 2009. Furthermore, doing compliance studies once every few years does not give IRS or others information about what is happening in the intervening years. Annual estimating of the compliance rate could provide information that would enable IRS management to adjust plans as necessary to help achieve the goal in 2009. One option that would not increase the cost of estimating compliance would be to use a rolling sample. IRS Oversight Board officials and we agree that instead of sampling, for example, once every 5 years, one-fifth of the sample could be collected every year. The total sample could include 5 years worth of data—with each passing year the oldest year would be dropped from the sample and the latest year added. The availability of current research data would allow IRS to more effectively focus its service and compliance efforts. For years, we have reported that tax law enforcement is a high-risk area, in part because of the size of the gross estimated tax gap, which IRS most recently estimated to be $345 billion for tax year 2001. IRS estimated it would recover around $55 billion through late payments and enforcement revenue, resulting in a net tax gap of around $290 billion. Reducing the tax gap would yield significant revenue and even modest progress, such as a 1 percent reduction, would likely yield nearly $3 billion annually. In recent years, IRS reported increases in enforcement revenue—revenue brought in as a result of IRS taking enforcement action. Between fiscal years 2003 and 2005, IRS reported that enforcement revenue grew from $37.6 billion to $47.3 billion, with a level of $48.1 billion estimated for 2006. However, the voluntary compliance rate has persisted at a relatively stable level. Further, GAO recently reported that tax returns prepared by paid tax preparers often contained errors such as unwarranted extra refunds and underreported income. These findings are consistent with NRP data which indicate that tax returns prepared by paid preparers contained a significant level of errors. These errors, whether they are the fault of the preparer or the result of taxpayers providing incomplete or inaccurate information, contribute to the tax gap. We have reported that significant reductions in the tax gap will likely require exploring new and innovative solutions. Such solutions that may not require significant additional IRS resources, but are nonetheless difficult to achieve, include simplifying the tax code to make it easier for individuals and businesses to understand and comply with their tax obligations; increasing tax withholding for income currently not subject to withholding; improving information reporting; and leveraging technology to improve IRS’s capacity to receive and process tax returns. IRS’s 2007 budget request includes five new legislative proposals to address some of these solutions to reduce the tax gap, along with a proposal to study independent contractor compliance that would not require additional resources. In recent testimony, the IRS Commissioner stated that the amount of enforcement revenue IRS expects from the legislative proposals will be $3.6 billion over the next 10 years (about 0.1 percent of the tax gap). However, the proposals should also increase revenue voluntarily paid without any IRS enforcement actions. The amount of that revenue is uncertain. The IRS Commissioner recognizes the implications of the tax gap and states in the budget that addressing it is a top priority. Although IRS’s 2007 budget request does not propose allocating IRS resources to new initiatives to reduce the tax gap, according to IRS officials, they plan to continue initiatives identified in prior budgets. For example, IRS has two ongoing BSM projects—F&PC and Modernized e-File—which, according to IRS’s Associate Chief Information Officer for BSM, could help reduce the tax gap. F&PC is expected to increase IRS’s capacity to resolve the growing backlog of delinquent taxpayer cases and increase collections, while Modernized e-File is expected to help make it easier for IRS to process tax returns, look for irregularities, and track down unpaid taxes. The budget request states that the administration will study the standards used to distinguish between employees and independent contractors for purposes of paying and withholding income taxes. We have long supported efforts aimed at improving independent contractor compliance. Past IRS data have shown that independent contractors report 97 percent of the income that is reported on information returns to IRS, while contractors that do not receive these information returns report only 83 percent of income. We have also identified other options for improving information reporting by independent contractors, including increasing penalties for failing to file required information returns, lowering the $600 threshold for requiring such returns, and requiring businesses to separately report on their tax returns the total amount of payments to independent contractors. We previously reported that clarifying the definition of independent contractors and extending reporting requirements for those contractors could possibly increase tax revenue by billions of dollars. Two of the legislative proposals call for more information reporting on payment card transactions from certain businesses and on payments by federal, state, and local governments to businesses. Information reporting has been shown to significantly reduce noncompliance. Although information reporting is highly effective in encouraging compliance, such reporting imposes costs and burdens on the businesses that implement it. However, information reporting is a way to significantly increase voluntary compliance without increasing IRS’s budget. Mr. Chairman, this completes my prepared statement. I would be happy to respond to any questions you or other members of the subcommittee my have at this time. For further information regarding this testimony, please contact James R. White, Director, Strategic Issues, on 202-512-9110 or whitej@gao.gov.or David A. Powner, Director, Information Technology Management Issues, on 202-512-9296 or pownerd@gao.gov. Contact points for our Offices of Congressional Relations and Public Affairs may be found on the last page of this statement. Individuals making key contributions to this testimony include Joanna Stamatiades, Assistant Director; Amanda Arhontas; Paula Braun; Terry Draver; Paul Foderaro; Chuck Fox; Tim Hopkins; Kathryn Horan; Hillary Loeffler; Sabine Paul; Cheryl Peterson; Neil Pinney; Steve Sebastian; Tina Younger. In 2002, Internal Revenue Service (IRS) entered into a 3-year agreement with the Free File Alliance, a consortium of 20 tax preparation companies to provide free electronic filing to taxpayers who access any of the companies via a link on IRS’s Web site. The 2002 Free File Agreement stated that as part of the agreement, IRS would not compete with the Consortium in providing free, online tax return preparation and filing services to taxpayers. IRS and the Consortium amended the agreement in 2005. Key differences between the two agreements are: the new income limitation of $50,000 and new language in the amendment that states the Alliance members must disclose early on if state tax return services are available, and if so, whether a fee will be charged for such services; and provide the necessary support to accomplish a customer satisfaction survey. It also added language pertaining to the marketing and offering of Refund Anticipation Loans (RALs) whereby: No offer of free return preparation and filing of an electronic return in the free file program shall be conditioned on the purchase of a RAL; and RALs will be offered with clear language indicating, for example, that RALs are loans, not a faster way of receiving an IRS refund; must be repaid even if the IRS does not issue a full refund; are short-term loans interest rates may be higher and customers may wish to consider using other forms of credit; and may be offered but not promoted. IRS tests each Consortium member’s software to ensure it is in accordance with the Free File provisions, including those cited previously, before allowing a link to IRS’s Web site. In addition, IRS officials monitor complaints about the Free File program received via IRS.gov, including allegations regarding false, deceptive, or misleading information or advertising. While IRS does not track the number of complaints it receives, according to IRS officials, most of the complaints received thus far were a result of the taxpayer either not carefully reading or following instructions, or incorrectly entering information. GAO conducted limited testing of the Free File program and found that the Consortium members were complying with the terms outlined in the amended Free File agreement pertaining to RALs. The amended Free File agreement contains provisions that enable IRS to monitor taxpayer participation beginning in the 2006 filing season, unlike prior years where Free File Alliance members self-reported filing figures. IRS also tracks the number of free file users who are accepting any financial products, such as RALs. As of April 17, IRS reported that 207,814 free file returns accepted financial products. This represents about 5 percent of all returns filed through the Free File program. The number of taxpayers using free file to electronically file their individual income tax returns has increased steadily from 2.8 million in 2003, to 3.5 million in 2004, to 5.1 million in 2005. The substantial growth between 2004 and 2005 was due to, in part, several Consortium members offering free filing to all taxpayers through the free file program regardless of their income in 2005. However, according to IRS officials, the lack of income limitation created conflict among Consortium members as it put pressure on all Alliance members to offer free service, which may not have been economically feasible for some, threatening competition if members were to drop out of the Alliance. IRS projected that 6.1 million taxpayers would use free file in 2006. However, this projection may be optimistic, because between January 1 and April 13, IRS has reported receiving only 3.5 million free file returns compared to 4.6 million during the same period last year, a decline of 24 percent. According to IRS officials, contributing factors to this decline are, in part, due to decreased press attention and advertising by the participating companies and the income limitation. The income limitation provides coverage to 70 percent of the nation’s taxpayers, or more than 92 million people. This coverage includes taxpayers with an adjusted gross income of $50,000 or less. For fiscal year 2007, the Internal Revenue Service (IRS) has requested $10.7 billion in its appropriation accounts. This request consists of $10.6 billion in direct appropriations and $135 million in revenue from new user fees, which IRS will commit to taxpayer service activities in its Processing, Assistance, and Management (PAM), Tax Law Enforcement (TLE), and Information System (IS) accounts. In addition, IRS is projecting to collect and use $282 million from existing user fees and reimbursable agreements with states and other federal agencies. This brings IRS’s proposed fiscal year 2007 budget to approximately $11 billion (a 1.6 percent increase over fiscal year 2006). After adjusting for expected inflation, IRS’s $11 billion budget request reflects a slight decrease from last year’s enacted budget. IRS’s enacted budgets for its appropriation accounts from fiscal years 2002 through 2007 are shown in table 4. IRS’s enacted budget has increased almost 8 percent since fiscal year 2002. By far, the biggest percentage increase has been in TLE—almost 21 percent—and is reflective of the shift in resources devoted to TLE from PAM during this period. The biggest percentage decrease was in the Business Systems Modernization (BSM) program, down almost 58 percent. Tables 5 and 6 show IRS’s enacted and actual Full-time Equivalents (FTEs) for fiscal years 2002 through 2007. Overall, actual FTEs tend to be lower than enacted FTEs due in part to the way IRS funds its unbudgeted costs. When both enacted and actual FTEs are considered, FTEs for PAM have steadily decreased and, for the most part, FTEs for TLE have increased since fiscal year 2002. However, steady trends are not apparent when comparing enacted and actual FTEs in IRS’s IS account. For example, when enacted FTEs are considered, IS staffing appears to fluctuate up and down between fiscal years 2002 through 2007; yet, when actual FTEs are considered, IS staffing decreased from fiscal year 2002 through 2005 and increased from fiscal years 2005 to 2006. IRS officials attribute these fluctuations in FTEs to reorganizations and other factors. Tables 5 and 6 also show significant differences in percentage changes between enacted and actual FTEs in some of IRS’s appropriations accounts from fiscal years 2006 to 2007. The enacted level of FTEs is the number IRS projected it could support given the level of funding the Congress enacted. According to IRS officials, enacted levels tend to be overstated compared to actual FTEs for several reasons. First, IRS, like most federal agencies, does not receive its budgets when expected and cannot fill all positions. Also, as the costs of maintaining current FTE levels increase annually, IRS is not able to realize all of the FTEs it projects to fund with the appropriations the Congress enacts. In its fiscal year 2006 budget request, IRS showed its budget distributed by taxpayer services and enforcement, including IS funding for those areas, because the agency’s current appropriation accounts are not divided clearly between taxpayer service and enforcement. As table 7 shows, funding for enforcement increased 15 percent between fiscal years 2004 and 2007 to $6.96 billion, while funding for taxpayer service declined over 3 percent to almost $3.6 billion. In its 2007 budget request, the Internal Revenue Service (IRS) is proposing to save over $121 million and 1,424 Full-time Equivalents (FTEs) and reinvest over $12 million and 11 FTEs. Based on IRS’s ability to achieve prior year savings and reinvestments as shown in table 8, we have a basis to believe that IRS will achieve most, if not all, of these savings. For example, IRS reported it realized 88 percent of its anticipated budget savings and 86 percent of its anticipated staff savings for savings identified in its fiscal year 2004 budget request, and IRS reported exceeding savings targets in fiscal year 2005. Of the 50 states, 12 have electronic filing mandates for tax preparers in effect for the 2006 filing season (see fig. 4). The mandates differ in their implementation dates and schedules, thresholds for filing, and penalties. The differences between mandates may affect the magnitude of electronic filing increases in each state. We recently reported that state mandates encourage electronic filing of federal tax returns and recommended that IRS develop better information about the costs to paid tax preparers and taxpayers of mandatory electronic filing of tax returns for certain categories of tax preparers. These mandates require tax practitioners who meet certain criteria, such as filing 100 individual state tax returns or more, to file individual state returns electronically. Between tax years 2001 and 2004, electronic filing had grown in the 9 states with mandates from an average of 36.7 percent to 56.8 percent, or an increase of over 20 percentage points, compared to an increase of 14 percentage points for the 41 non mandated states over the same time period. We expect this trend to continue as 3 additional states—New York, Utah and Connecticut—implemented mandates in time for the 2006 filing season. Of these 3 states, New York may have the most to gain because it currently has the lowest rate of electronic filing rate, with fewer than 38 percent of its nearly 9 million federal individual income tax returns electronically filed last year. Tax Administration: IRS Improved Some Filing Season Services, but Long-Term Goals Would Help Manage Strategic Trade-offs, GAO-06-51 Washington, D.C.: November 14, 2005. Tax Administration: IRS Improved Performance in the 2004 Filing Season, but Better Data on the Quality of Some Services Are Needed, GAO-05-67 Washington, D.C.: November 10, 2004. Tax Administration: IRS’s 2003 Filing Season Performance Showed Improvements, GAO-04-84 Washington, D.C.: October 31, 2003. IRS’s 2002 Tax Filing Season: Returns and Refunds Processed Smoothly; Quality of Assistance Improved, GAO-03-314 Washington, D.C.: December 20, 2002. Internal Revenue Service: Assessment of Fiscal Year 2006 Budget Request, GAO-05-566 Washington, D.C.: April 27, 2005. Internal Revenue Service: Assessment of Fiscal Year 2006 Budget Request and Interim Results of the 2005 Filing Season, GAO-05-416T Washington, D.C.: April 14, 2005. Internal Revenue Service: Assessment of Fiscal Year 2005 Budget Request and 2004 Filing Season Performance, GAO-04-560T Washington, D.C.: March 30, 2004. Tax Gap: Making Significant Progress in Improving Tax Compliance Rests on Enhancing Current IRS Techniques and Adopting New Legislative Actions, GAO-06-453T Washington, D.C.: February 15, 2006. Tax Gap: Multiple Strategies, Better Compliance Data, and Long-Term Goals Are Needed to Improve Taxpayer Compliance, GAO-06-208T Washington, D.C.: October 26, 2005. Tax Compliance: Reducing the Tax Gap Can Contribute to Fiscal Sustainability but Will Require a Variety of Strategies, GAO-05-527T Washington, D.C.: April 14, 2005. Taxpayer Information: Data Sharing and Analysis May Enhance Tax Compliance and Improve Immigration Eligibility Decisions, GAO-04- 972T Washington, D.C.: July 21, 2004. Compliance and Collection: Challenges for IRS in Reversing Trends and Implementing New Initiatives, GAO-03-732T Washington, D.C.: May 7, 2003. Financial Audit: IRS’s Fiscal Years 2005 and 2004 Financial Statements, GAO-06-137 Washington, D.C.: November 10, 2005. Internal Revenue Service: Status of Recommendations from Financial Audits and Related Financial Management Reports, GAO-05-393 Washington, D.C.: April 29, 2005. Financial Audit: IRS’s Fiscal Years 2004 and 2003 Financial Statements, GAO-05-103 Washington, D.C.: November 10, 2004. Internal Revenue Service: Status of Recommendations from Financial Audits and Related Financial Management Reports, GAO-04-523 Washington, D.C.: April 28, 2004. Financial Audit: IRS’s Fiscal Years 2003 and 2002 Financial Statements, GAO-04-126 Washington, D.C.: November 13, 2003. Business Systems Modernization: IRS Needs to Complete Recent Efforts to Develop Policies and Procedures to Guide Requirements Development and Management, GAO-06-310 Washington, D.C.: March 20, 2006. Business Systems Modernization: Internal Revenue Service’s Fiscal Year 2006 Expenditure Plan, GAO-06-360 Washington, D.C.: February 21, 2006. Business Systems Modernization: Internal Revenue Service’s Fiscal Year 2005 Expenditure Plan, GAO-05-774 Washington, D.C.: July 22, 2005. IRS Modernization: Continued Progress Requires Addressing Resource Management Challenges, GAO-05-707T Washington, D.C.: May 19, 2005. Business Systems Modernization: IRS’s Fiscal Year 2004 Expenditure Plan, GAO-05-46 Washington, D.C.: November 17, 2004. Business Systems Modernization: Internal Revenue Service Needs to Further Strengthen Program Management, GAO-04-438T Washington, D.C.: February 12, 2004. IRS Modernization: Continued Progress Necessary for Improving Service to Taxpayers and Ensuring Compliance, GAO-03-796T Washington, D.C.: May 20, 2003. Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made Serious Errors, GAO-06-563T Washington, D.C.: April 4, 2006. Tax Administration: IRS Can Improve Its Productivity Measures by Using Alternative Methods, GAO-05-671 Washington, D.C.: July 7, 2005. 21st Century Challenges: Reexamining the Base of the Federal Government, GAO-05-325SP Washington, D.C.: February 2005. High Risk Series: An Update, GAO-05-207 Washington, D.C.: January 21, 2005. Internal Revenue Service: Challenges Remain in Combating Abusive Tax Schemes, GAO-04-50 Washington, D.C.: November 19, 2003. Tax Administration: IRS Is Implementing the National Research Program as Planned, GAO-03-614 Washington, D.C.: June 16, 2003. Tax Administration: IRS Needs to Further Refine Its Tax Filing Season Performance Measures, GAO-03-143 Washington, D.C.: November 22, 2002. This is a work of the U.S. government and is not subject to copyright protection in the United States. It may be reproduced and distributed in its entirety without further permission from GAO. However, because this work may contain copyrighted images or other material, permission from the copyright holder may be necessary if you wish to reproduce this material separately.

Summary: The Internal Revenue Service's (IRS) filing season performance affects tens of millions of taxpayers who expect timely refunds and accurate answers to their tax questions. IRS's budget request is a planning tool showing how it intends to provide taxpayer service and enforce the tax laws in 2007. It is also the first in a series of annual steps that will determine whether IRS meets its new long-term goals of increasing tax compliance and reducing taxpayers' acceptance of cheating on their taxes. Tax law enforcement remains on GAO's list of high-risk federal programs, in part, because of the persistence of a large tax gap. IRS recently estimated the gross tax gap, the difference between what taxpayers owe and what they voluntarily pay, to be $345 billion for 2001. GAO assessed (1) IRS's interim 2006 filing season performance; (2) the budget request; and (3) how the budget helps IRS achieve its longterm goals. GAO compared performance and the requested budget to previous years. IRS has improved its filing season performance so far in 2006, continuing a trend. More refunds were directly deposited, which is faster and more convenient. Electronic filing continued to grow, but at a slower rate than in previous years. IRS's two most commonly used services--telephone and Web site assistance--continued to improve. IRS estimates that the accuracy rate for its telephone answers is now at 90 percent or more. Taxpayers continued the recent pattern of using IRS's walk-in sites less and community-based volunteer sites more. While millions of taxpayers use chain paid tax preparers, taxpayers may not be receiving accurate and complete assistance, putting them at risk of owing back taxes, interest, and penalties. The 2007 budget request of $11 billion (a small decrease after adjusting for inflation) sets performance goals for service and enforcement that are all equal to or higher than the 2006 goals. The budget reduces funding by 15 percent for Business Systems Modernization, the ongoing effort to replace IRS's aging information systems. The reduction could impede progress delivering improvements to taxpayers. The budget request identified over $121 million in savings; however, opportunities exist for further savings. For example, IRS officials told us IRS's 25 call centers have underutilized space. Those centers could be consolidated without affecting service to taxpayers. Achieving IRS's long-term compliance goals will be challenging because the tax gap has persisted for many years at about its current level. In addition, because the effect of taxpayer service and enforcement on compliance has never been quantified, IRS does not have a data-based plan demonstrating how it will achieve its goals. Nor does IRS have a plan for measuring compliance by 2009, the date for achieving the goals. Reducing the tax gap will likely require new and innovative solutions such as simplifying the tax code, increasing income subject to withholding, and increasing information reporting about income.