IRS has 10 submission processing centers located throughout the country that are responsible for processing paper returns, 5 of which also process electronic returns. Electronic returns are relatively easy to process, while the processing of paper returns involves several additional steps, as shown in figure 1. The fewer steps involved in processing electronic returns rather than paper returns relate to a cost avoidance experienced by the IRS. In response to a question raised by the House Appropriations Committee in 2001, IRS estimated that 50 million individual income tax returns would be filed electronically in fiscal year 2002. IRS estimated that it would need 3,150 more full-time equivalent staff years if none of those returns were filed electronically. At IRS’ estimate of $36,300 per staff year, that would be a cost avoidance of $114.3 million. Therefore, if no returns were filed electronically and using IRS’ estimates, which we did not verify, IRS’ fiscal year 2002 budget request of $615 million for submission processing would have increased to about $729 million. The major focus of our review was on factors that worked against an even greater reduction in submission processing costs. To address our objectives, we interviewed IRS National Office officials and officials at 2 of the 10 submission processing centers—Atlanta and Cincinnati—to obtain their opinions about any factors that limited the impact of electronic filing on the amount of resources devoted to processing returns from fiscal years 1997 through 2000. We reviewed IRS documents and GAO reports that contained information related to these factors. We analyzed a report prepared for IRS by the consulting firm of Booz-Allen & Hamilton about future prospects for cost reductions in submission processing and obtained IRS officials’ opinions on that subject. We performed our work between January and October 2001 in accordance with generally accepted government auditing standards. We discuss our scope and methodology in greater detail in appendix I. Several factors limited the impact of electronic filing on the resources devoted to processing returns from fiscal years 1997 through 2000. These factors fell into two broad categories—filing trends that partially offset the potential savings from increases in electronic filing and expanded demands on paper processing staff. Even though the number of electronic returns filed from 1997 though 2000 increased, the potential savings from that increase were partially offset by the following filing trends: The increase in electronically filed returns was partially offset by an increase in total returns filed. The number of the most complex individual income tax returns filed on paper—standard Form 1040s—essentially stayed the same. The number of paper individual income tax returns received by IRS during the peak filing period stayed relatively the same from 1997 through 2000, and peak processing needs drive the resources needed to process individual paper returns. About 17.9 million more individual and business tax returns were filed electronically in 2000 than in 1997. However, as shown in table 1, because of an overall increase in the total number of returns filed from 1997 through 2000, the net decline in paper returns over that period was much less than the 17.9 million net increase in electronic filings. Thus, the increase in electronic returns had less of an impact on processing costs than might have been expected because any savings from that increase would be partially offset by the costs to process the overall increase in returns filed. From 1997 through 2000, the number of complex individual returns filed on paper essentially remained the same. The complexity of a return varies according to the form on which it is filed. Complexity is determined by the number of lines of data that need to be entered on a form. According to IRS submission processing officials, the standard Form 1040 is the most complex. Complexity then decreases from the Form 1040 to the Form 1040A, and finally to the Form 1040EZ. The more complex a return, the longer it takes to process and the greater the processing costs. For example, according to data developed for IRS by a consulting firm for fiscal year 1999, the average direct labor cost to process a Form 1040 filed on paper was $1.93 compared to $1.50 to process a paper 1040A and $1.01 to process a paper 1040EZ. As shown in table 2, the number of Form 1040s filed on paper only decreased by about 1 percent from 1997 through 2000, with the only decrease occurring between 1999 and 2000. The reductions in paper 1040As and 1040EZs were much larger during the years covered by our study—15 and 23 percent, respectively. Any reductions in processing costs that IRS may have been able to realize as more taxpayers filed electronically depended, in great part, on the cost of processing those same returns filed on paper. IRS would have been able to reduce costs more if a greater number of taxpayers who were filing the more complex (and thus more costly to process) returns on paper had started filing electronically. Another filing trend that limited the impact of electronic filing on processing costs was the increase in the number of paper returns filed by individuals during the peak filing period—the 2 weeks of the year when the most individual income tax returns are filed. The peak filing period for paper returns filed by individuals is mid-April. Business returns do not experience the same peak phenomenon. Businesses have various fiscal years, which affect their filing period. In addition, many business returns must be filed quarterly. As shown in table 3, while the overall number of individual returns filed on paper decreased from 1997 through 2000, the number of paper returnsfiled during the peak period stayed relatively the same. The number of paper individual returns received during the peak filing period drives the amount of resources needed to process individual paper returns. According to the Director of Submission Processing, when Submission Processing determines its resource needs, the first priority is the resources (including staff, equipment, and space) needed during the peak period. The Director added that, all things considered, if the number of individual paper returns received during the peak period increases while the total number of paper returns received during the entire year decreases, the increase during the peak period would have more of an impact on submission processing resources than would the overall decrease in paper receipts. IRS’ goal of improving business results also directly affects the resources needed during the peak filing period. To help achieve this goal, in 2000, 85 percent of refund checks for paper returns were to be processed within 40 days. Doing so also contributes to IRS’ goal of improving taxpayer satisfaction. Thus, to meet these goals, IRS has to ensure that there are enough resources to process the increased number of peak period returns within this time frame. Another factor that limited the impact of electronic filing on the resources devoted to paper processing was the increase in demands placed on paper processing staff from 1997 through 2000. These increased demands included the following: Numerous processing changes increased the workload for units responsible for (a) reviewing returns for completeness and coding them for data entry, (b) transcribing data, and (c) correcting errors. Because most electronic filers submitted a paper signature document, the work done by paper processing staff was not totally eliminated when taxpayers filed electronically and the volume of that work increased as electronic filing increased. Front-line employees spent increasing amounts of time on activities, including training, not specifically related to processing returns. Numerous changes were made in the processing of returns from 1997 through 2000, which according to IRS officials, resulted in an increased workload. For paper processing staff, these changes generally increased the amount of time spent reviewing returns and coding them for data entry, number of keystrokes entered, and number of IRS and taxpayer errors to be corrected. Table 4 illustrates the estimated effects of some of these changes according to IRS’ data. Some processing changes, such as the validation of secondary Social Security numbers, were made to help ensure compliance with the tax law. Other changes stemmed from changes in the tax law that established new credits and deductions for which IRS had to enter data into its computer system. Although the numbers of additional seconds and keystrokes cited in table 4 for any one change are small, the overall effect of these processing changes, considering the number of returns involved, is to increase the number of staff years needed to process returns. For example, the additional second needed to review and code 41.6 million returns for secondary Social Security number validation equates to about 11,556 hours or (on the basis of 2,088 hours per staff year) 5.5 staff years. Similarly, a total of about 584.5 million additional keystrokes would have had to be made to process the four changes in table 4, which, we roughly estimated using IRS data on average keystrokes per hour, would consume at least 78,000 additional hours or 37.4 staff years at a cost of almost $1.4 million.Although these changes in workload may not be of great magnitude, they required additional resources that offset some of the potential savings from electronic filing. The workload of error correction staff can also be affected by changes in the accuracy of work done by other processing staff. In that regard, the accuracy of staff who reviewed and coded tax returns for transcription increased from 95 percent in 1997 to 96.6 percent in 2000, while the accuracy of data transcribers decreased from 94.7 percent to 93.9 percent. We do not know how much, if at all, the volume of error correction work actually changed as a net result of these increases and decreases in accuracy. The increase in responsibilities can also affect the staff’s productivity. Using IRS information on average keystrokes per hour for various tax forms as a measure of data transcribers’ productivity, table 5 shows that there was a general decline in productivity in 1999, which is when transcribers began using a new computer system, and a general improvement in productivity in 2000. For example, IRS data for Other- Than-Full-Paid Form 1040s showed that the average keystrokes per hour went from 7,503 in 1997 to 7,250 in 1998 and 6,802 in 1999 before rising to 7,108 in 2000. Submission Processing officials said that many factors affected accuracy and productivity and that it would be difficult to determine specifically what caused them to decrease.