Madam Chairman and Members of the Subcommittee: We are pleased to be here today to participate in the Subcommittee’s inquiry into the Internal Revenue Service’s (IRS) financial condition for 1996, the status of the 1996 filing season, and the administration’s fiscal year 1997 budget request for IRS. Our statement is based on work we have been doing for the Subcommittee and our past reviews of filing season activities, Tax Systems Modernization (TSM), and compliance initiatives. July 1995 report. Although IRS has initiated actions in response to these weaknesses, those efforts provide little assurance that the weaknesses will be corrected in the near term. As a result, we believe that additional investments in TSM are at risk. The largest program increase in IRS’ fiscal year 1997 budget request is $359 million for certain compliance programs. Our past work on compliance initiatives identified several problem areas, including (1) IRS’ inability to fully implement past initiatives, (2) the inaccuracy of IRS’ tracking of the revenue from such initiatives, and (3) the focus of past collection initiatives on hiring revenue officers instead of more productive collection staff. Although IRS has taken some actions to address our concerns, some issues remain, particularly in terms of the reliability of IRS’ data. IRS’ fiscal year 1996 appropriation was $7.3 billion. That amount was about $860 million less than the President requested for fiscal year 1996 and about $160 million less than IRS’ fiscal year 1995 appropriation. In June 1995, anticipating possible reductions from the amount the President had requested for fiscal year 1996, IRS began taking steps to reduce its staffing levels. On June 30, 1995, IRS announced a hiring freeze. Earlier in 1995, IRS had announced an early-out program without incentives for employees affected by its district office and regional office consolidations. After enactment of its final appropriation, IRS reopened the early-out program through February 3, 1996, and made it available to all employees. About 1,690 staff retired as a result of this program. implement a RIF for fiscal year 1996, the cost would have exceed the savings. As of March 1, 1996, according to IRS officials, IRS had about $140 million in unfunded mandatory nonlabor costs for fiscal year 1996. Some of those unfunded costs were for telecommunications, postage, and rent. IRS officials said that they are hoping to resolve these unfunded costs without having to resort to furloughs. Part of the $140 million shortfall stems from lower user-fee receipts than expected. IRS’ fiscal year 1996 appropriation assumed a receipt of $119 million from user fees. IRS now expects to receive from $60 to $70 million in such fees for fiscal year 1996. As noted earlier, IRS’ actions to reduce labor costs involved steps directed at seasonal and nonpermanent staff. Most of IRS’ seasonal and non-permanent staff (1) help process tax returns during the filing season, (2) assist taxpayers either at walk-in offices or over the telephone, and (3) work in compliance programs that do not require face-to-face interaction with taxpayers. IRS officials told us that in deciding which areas to cut, IRS wanted to ensure that it could process tax returns and issue refunds in a timely manner. As a result, most of IRS’ staffing cuts affected its compliance programs, with some cuts in the taxpayer service area. According to IRS officials, the two compliance programs that employ the largest number of seasonal and term staff are (1) the Document Matching program, through which IRS identifies taxpayers that either underreport their income or do not file required tax returns, and (2) the Automated Collection System (ACS), through which IRS staff try to contact delinquent taxpayers or nonfilers by telephone and resolve the delinquency. Because IRS’ cost-cutting measures for fiscal year 1996 focused on seasonal and nonpermanent staff, these two programs were significantly affected. Through the Document Matching program, IRS matches income reported on tax returns with information provided by third parties, such as wage information from employers and interest and dividend information from financial institutions. Those matches are to identify taxpayers that underreported their income (underreporters) and those that did not file required tax returns (nonfilers). According to IRS, it spent about 1,950 staff years on underreporter activities in fiscal year 1995 and closed 4.1 million cases with recommended tax assessments of $1.7 billion. Because of staff reductions, IRS estimates that it will spend about 1,300 staff years on underreporter activities in 1996—about a 33-percent reduction—and close about 1.5 million fewer cases. IRS estimates that its assessments from closed cases will be $1.4 billion, $300 million less than in 1995. IRS’ matching program also identifies taxpayers who have not claimed refunds to which they are entitled. In fiscal year 1995, IRS issued $120 million in refunds through that program. IRS expects that amount to drop to $95 million in 1996 because of staff reductions. Also under the Document Matching program, IRS creates returns for nonfilers using information documents provided by third parties. According to IRS, it spent about 600 staff years on that effort in fiscal year 1995, closed about 810,000 cases, and assessed $1.9 billion. Because of staff reductions, IRS estimates that it will spend about 370 staff years on this effort in fiscal year 1996—about a 38-percent reduction—and close about 180,000 fewer cases. IRS estimates that assessments from closed cases will be $1.3 billion, $650 million less than in 1995. Once a tax delinquency or delinquent return is identified, IRS uses a three-stage process to collect the tax or secure the return. In the first stage, taxpayers are mailed a series of notices. If the case is not resolved at this point and meets certain criteria, it is transferred to ACS. At this stage, IRS staff in call sites contact the taxpayer or nonfiler by telephone. If the case remains unresolved at this point and meets certain criteria, it is transferred to a revenue officer, who is to visit the taxpayer or nonfiler or take other steps to secure the delinquent return and/or collect the delinquent tax. Because of various factors discussed in the appendix, ACS had a significant number of seasonal, term, and other than full-time permanent staff at the end of fiscal year 1995—66 percent more than it had at the end of fiscal year 1994. As a result, ACS was targeted for a significant staff reduction when IRS decided to reduce the number of hours for seasonal staff and not extend appointments for term employees. other compliance staff to ACS. These details are to remain in effect for at least 1 year. IRS officials said that they plan to revisit this agreement with the union once IRS knows its budget situation for fiscal year 1997. On the basis of our past filing season reviews, we had several questions going into the 1996 filing season: How will IRS’ staffing reductions for fiscal year 1996 affect its ability to process returns and assist taxpayers? Will last year’s drop in the number of electronic filings be reversed? What can taxpayers expect in the way of refund delays in 1996? Will the steady decline in the accessibility of IRS’ telephone assistance over the past several years continue? Has the performance of IRS’ Service Center Recognition/Image Processing System (SCRIPS) improved? As discussed below, preliminary information addressing these questions indicates that, in certain key respects, the 1996 filing season is progressing more smoothly than did the 1995 season. As also discussed below, however, there are still several concerns that we will be monitoring during our continuing assessment of filing season activities. Specifically, (1) although telephone accessibility is up, it is still very low; (2) IRS closed many walk-in sites this year that had provided assistance to taxpayers in the past; and (3) SCRIPS is still not meeting its original expectations. In deciding where to make the staffing cuts for fiscal year 1996, IRS wanted to make sure it had enough staff to do its most critical functions—process returns and issue refunds—in a timely manner. Available data indicate that IRS has been successful in that regard. As of March 15, 1996, IRS’ 10 service centers had processed 71 percent of the paper individual income tax returns they had received (the same percent as last year), and the centers were processing that workload in about the same cycle time as last year (within an average of 8 to 13 days, depending on the type of individual income tax return filed). were unable to verify whether the refund cycle time has changed because the data we use to track refund timeliness were not available at the time we prepared this statement. Although IRS has apparently been able to process returns and issue refunds this year without any significant problems, staffing cuts in other areas could be affecting its ability to serve taxpayers and identify questionable refund claims. In the taxpayer service area, IRS closed 93 walk-in assistance sites, reduced the operating hours of some of the 442 sites that remained open, and eliminated free electronic filing at 195 of the sites. According to IRS, the closed sites were selected on the basis of their historical volume of work and their proximity to other walk-in sites. As an indication of the effect of these closures and cutbacks, IRS data show that walk-in sites served about 1.7 million taxpayers from January 1 through March 9, 1996—about 16 percent fewer taxpayers than were served at the same time last year. Walk-in sites provide various free services, including copies of the more commonly used forms and publications, help in preparing returns, and answers to tax law questions. There are other ways taxpayers can obtain those services free, although maybe not as easily. Taxpayers needing forms and publications, for example, might find them at their local library or can get them by calling IRS’ toll-free forms-ordering number.