If IRS’s budget request is approved, IRS will have more than 3,400 staff years that can be assigned to new or existing activities in fiscal year 2003. These include the 1,179 additional staff years requested in the budget and the 2,287 staff years that IRS determined could be redirected elsewhere in the organization due to projected savings from several improvement projects and workload decreases. These 3,400 staff years can make a real impact on IRS’s performance if they are targeted to selected areas. However, the availability of these staff years depends on the projected savings being realized and no significant unanticipated expenses. In addition, it is difficult to evaluate the effect that these additional and redirected staff years will have on IRS’s operations because the budget is not well-linked to performance goals in some important areas. With respect to that part of the budget request for information technology, IRS (1) did not adequately support the $1.63 billion requested for operation and maintenance of its information systems but (2) did adequately support its $450 million request for business systems modernization. IRS’s fiscal year 2003 budget request is based on several assumptions that could prove optimistic. These include (1) labor and nonlabor savings of 2,287 staff years and $157.5 million from various improvement projects and workload decreases that IRS plans to use elsewhere in the organization, and (2) additional savings of $38.5 million resulting from better business practices that have not yet been identified. Also, IRS may face some unanticipated expenses that, if not funded, could cause it to revise its financial plan for fiscal year 2003. In many respects, this kind of uncertainty is the natural result of a process that requires the development of budget estimates many months before the fiscal year in question. No matter the reason, the end result could be unrealized savings or unexpected expenses that, as in the past, lead to cutbacks in planned hiring—cutbacks that historically have hit IRS’s enforcement programs the hardest. Through use of its strategic planning, budgeting, and performance management process, IRS identified a myriad of expected efficiency improvements, technological enhancements, labor-saving initiatives, and workload decreases that it projects will enable it to redirect $157.5 million in its base budget to higher-priority areas. Examples include (1) saving over $67 million from re-engineering and quality improvement efforts, such as consolidating form printing and distribution operations and updating an antiquated workload selection system to reduce or eliminate the substantial number of tax returns that are ordered but never audited, and (2) reducing the resources used for the innocent spouse program by $13.8 million due to an expected decrease in caseload. We commend IRS for taking the initiative to reassess the allocation of resources in its base budget. However, the congressional justification submitted by IRS in support of its budget request does not explain how IRS developed the labor and nonlabor savings. IRS provided us with information on the overall method used to develop the savings and explained that, in a change from IRS’s previously used top-down process, operating units determined the resource increases and decreases their programs needed. However, IRS did not provide details on how specific savings were computed, such as information on any assumptions used in developing specific estimates. In response to the secretary of the Treasury’s challenge for each Treasury bureau to review all programmatic efforts and reduce or remove those producing little or no value, IRS officials estimated that such a review could save $38.5 million. IRS’s congressional justification notes that the secretary considers this review to be a work in progress and expects bureau heads and financial plan managers “to work creatively on mid- course adjustments” until the final quarter of fiscal year 2003. Accordingly, the congressional justification provides no details on how the $38.5 million will be achieved. Any shortfall in the estimated labor and nonlabor savings or in savings from efforts to reduce or eliminate programs will only be exacerbated if IRS has to absorb unanticipated budget increases. For example, IRS officials estimated that it would cost an additional $69 million if the civilian pay raise included in this budget was increased to achieve parity with the proposed pay raise for the military. In fiscal year 2002, IRS faced unbudgeted cost increases related to rent, pay raises, security, and postage rate increases. As a result, IRS had to delay hiring revenue agents and officers, tax compliance officers, and tax specialists. According to IRS, “the lack of full funding for non-labor inflation over the years has greatly reduced the IRS ability to cover pay raise costs and other legitimate cost increases by reducing non-labor costs, leaving the IRS with the sole alternative of reducing staff.” IRS noted that “these budget constraints forced the IRS to reduce 1,364 FTEs in the 2002 plan.” Although we do not have specific evidence of how this FTE reduction affected IRS’s operations, IRS data does indicate that the number of revenue agent FTEs in its current financial plan for fiscal year 2002 (11,836) is 691 fewer than the actual revenue agent FTEs in fiscal year 2000 (12,527)—despite funding of an initiative in fiscal years 2001 and 2002 that, among other things, was to increase the number of revenue agent FTEs. The Government Performance and Results Act of 1993 requires agencies to establish linkages between resources and results. With this requirement, Congress hoped to focus agencies on achieving better results for the American public. Congress also hoped to gain a better understanding of what is being achieved in relation to what is being spent. In some respects, IRS’s congressional justification has good links between the resources being requested and IRS’s performance goals. For example, IRS’s budget includes an increase of 213 FTEs and $14.1 million to improve its telephone level of service, and its performance measures show an expected increase in toll-free telephone level of service from 71.5 percent in fiscal year 2002 to 76.3 percent in fiscal year 2003. However, in other important areas, the congressional justification is not well-linked to performance goals. In some instances, there are no performance goals against which Congress can hold IRS accountable. In other instances, there seem to be inconsistencies between the amount of resources being requested and the expected change in performance or workload. A significant example of missing performance goals involves IRS’s efforts to address major areas of systematic noncompliance. In February 2002, the commissioner of Internal Revenue identified four such areas: (1) misuse of devices, such as trusts and passthroughs, to hide income; (2) use of complex and abusive corporate tax shelters to reduce taxes improperly; (3) failure to file and pay large accumulations of employment taxes; and (4) erroneous refund claims, which include claims made under the Earned Income Credit (EIC) program. The budget request includes increased resources for compliance but, except for the EIC program, it is unclear from IRS’s congressional justification how many resources IRS intends to devote to each of these problems. And, for none of these areas, including the EIC program, does the congressional justification include performance measures and goals that Congress can use to assess IRS’s progress in addressing these major compliance problems. IRS’s congressional justification is clear about the amount of resources IRS plans to devote to EIC compliance efforts because the budget request calls for the continuation of a separate appropriation for that program. If approved, it will be the sixth year of targeted funding for the EIC program. IRS’s compliance efforts under this program have prevented the payment of hundreds of millions of dollars of improper EIC claims. However, the most recent IRS information shows that the rate of EIC noncompliance is still very high. According to IRS’s report on its analysis of EIC compliance rates on tax year 1999 returns filed in 2000, (1) about one-half of the 18.8 million returns on which taxpayers claimed the EIC involved overclaims and (2) of the estimated $31.3 billion in EIC claims made by taxpayers who filed returns in 2000, between $8.5 billion and $9.9 billion should not have been paid. Audit coverage is another area where performance goals would help Congress assess IRS’s progress. IRS states in its congressional justification that it will increase the resources for stabilizing audit rates by 368 FTEs and $24 million. Although the congressional justification states that audit rates have fallen, the justification does not include any information about current audit rates or what rates IRS expects to achieve in 2003. Given the amount of resources that could be involved in dealing with the four major compliance problems cited by the commissioner and increasing overall audit coverage, the Subcommittee may want to ask IRS to provide (1) more specifics on the level of resources it plans to devote to each of these areas and its performance measures and goals for each area and (2) its views on maintaining a separate appropriation for the EIC versus combining in one appropriation those resources with the resources being requested for other compliance work, which could give IRS more flexibility in deciding how best to allocate its resources among all of its compliance needs. The budget request and performance goals included in the congressional justification are, at times, inconsistent. Some of those inconsistencies might suggest that additional resources beyond those identified by IRS are available for redirection. Specific examples of inconsistencies include the following: A requested increase of 476 staff years and $20.7 million for “increased Offer-in-Compromise cases” is inconsistent with IRS’s performance goal for that program, which shows that the number of cases processed is expected to decrease from 185,000 in 2002 to 104,600 in fiscal year 2003. This requested increase also conflicts with our recent evaluation of the program that shows that IRS projected that the number of staff years needed would decrease from 1,818 in fiscal year 2002 to 1,224 in fiscal year 2003.