IRS and state revenue offices are both charged with responsibility for collecting taxes. More than half of the states have based their income tax systems on the federal tax system, with an overlap of many taxpayers. For the most part, this common customer base is dealt with separately by IRS and the state agencies. Given their common roles and customer bases, opportunities for collaboration among IRS and states’ revenue offices exist. IRS is facing budget reductions and downsizing. Because of decreasing resources, it becomes even more important to identify ways that IRS and the states can cooperate to improve efficiencies and maximize their return on investment. IRS and the states have been involved in cooperative tax administration efforts since the 1920s. By engaging in cooperative efforts, state agencies and the federal government have attempted to achieve greater compliance and efficiency than they could by working separately. Early cooperative efforts involved the sharing of taxpayer income and tax liability information. In 1957, these activities became governed by formal agreements between IRS and the states to specify the types of tax information to be shared. In 1978, IRS fixed responsibility for the exchange of federal and state tax information with the disclosure officers in its regional and district offices. IRS also charged its district directors with responsibility for working personally with state tax agencies to establish and conduct FedState cooperative projects. In 1991, the Office of FedState Relations was established in the National Office to facilitate cooperative tax administration and foster joint projects. IRS originally assigned a senior executive and five staff to this office. IRS chose to not provide full-time field staff to facilitate and foster projects. District directors continued to be responsible for liaison and personal involvement. Most disclosure officers were assigned responsibility for coordinator and facilitator duties on a part-time basis. As of November 1995, 49 states were participating in the FedState program, and, according to IRS officials, approximately 600 to 700 projects were ongoing or proposed. In recent years, IRS and the Department of the Treasury have drafted and proposed legislation to further the FedState program. In June 1995, the President announced that he would submit to Congress proposed legislation to facilitate additional FedState cooperative efforts to streamline tax administration, such as joint filing and processing of return information. The proposed legislation would allow IRS and state taxing agencies to delegate tax administration powers and compensate one another pursuant to agreements. The most recent version of the legislation was submitted to Congress in March 1996. No action has been taken yet. In 1978 and 1985, we issued reports on the FedState program. The 1978 report to the Joint Committee on Taxation concluded that the program had a low priority within IRS and had no unified direction because responsibility for the program was not fixed. In response, IRS assigned program responsibility to the Office of Disclosure Operations. Both the 1978 and 1985 reports concluded that IRS and the states were not using much of their exchanged data and were not sharing other potentially useful information. In response, IRS established reviews to determine if states needed and used the confidential return information provided by IRS. Our review of the FedState program arose from a December 9, 1994, hearing on compliance costs and taxpayer burden held by the Subcommittee on Oversight of the House Committee on Ways and Means. At that hearing, the Subcommittee expressed interest in how the states and the federal government could work together to reduce taxpayer burden. Our objectives for this report were to (1) identify the potential benefits of FedState cooperative efforts; (2) determine what, if any, conditions may impede the success of the program; and (3) determine what, if any, FedState program concerns the states have with IRS’ planned reorganization. To achieve our interrelated objectives, we interviewed IRS officials responsible for the FedState program in IRS’ national and southeast regional offices, as well as its Albany, NY; Atlanta, GA; Baltimore, MD; Columbia, SC; Phoenix, AZ; and St. Paul, MN, district offices. We interviewed state revenue department officials knowledgeable of FedState activities in Arizona, Georgia, Maryland, Minnesota, New York, and South Carolina. These locations were selected on the basis of their proximity to our offices or because IRS officials said they were characterized by a high level of FedState activity. We also (1) reviewed FedState documents, such as the 1994 FedState Cooperative Ventures Catalog and the FedState Concept of Operations Report from IRS, and program reports from state department of revenue offices we visited; (2) collected detailed information, such as project descriptions and any data on costs and benefits, on FedState projects in the states we visited; and (3) reviewed various legislative proposals related to FedState activities. We interviewed Federation of Tax Administrators (FTA) officials knowledgeable of the FedState program. FTA represents state tax administrators and is actively involved in promoting effective working relationships among IRS and state tax agencies. We held a group discussion with and surveyed state tax administrators on their views regarding cooperative FedState efforts at the June 1995 FTA conference in Cleveland, OH. Participation in the discussion and survey was voluntary. Our work was done between January 1995 and April 1996 in accordance with generally accepted government auditing standards. We provided a draft of this report to the Commissioner of Internal Revenue and the Executive Director, FTA, for their comments. We met with FTA on August 15, 1996, and with IRS officials on September 4, 1996, to discuss this report. Their comments are summarized and evaluated beginning on page 13 and incorporated into this report where appropriate. Due to the similarities in the functions of IRS and state revenue departments, numerous opportunities exist to improve tax administration efficiencies through FedState cooperative efforts. For example, taxpayer data tape exchanges can improve compliance and enforcement by enabling IRS and the states to identify noncompliant taxpayers and take appropriate action. Similarly, joint federal and state taxpayer education and assistance efforts can reduce taxpayer burden by making it easier for taxpayers to obtain information about tax requirements. More sophisticated technology provides additional ways for IRS and the states to reduce taxpayer burden. For example, in one district the state and IRS can automatically transfer telephone taxpayer assistance calls to each other to respond to taxpayers more quickly and efficiently. Data limitations prevented us from ascertaining whether the existing mix of FedState projects has helped IRS toward meeting its goals of improving compliance, increasing efficiency, and reducing taxpayer burden. A project designed to increase compliance may also have the positive effect of reducing burden or increasing efficiency. An official in IRS’ Office of FedState Relations told us that four of the most common efforts have been taxpayer data tape exchanges, federal/state joint electronic filing programs, state refund offset programs, and the joint dyed diesel fuel program. Taxpayer data tape exchanges, which began in the 1960s, constitute one of the oldest FedState cooperative efforts. According to IRS, currently almost all states participate in tape and information exchanges. By exchanging tapes that include taxpayer return data, IRS and the states have been able to identify taxpayers who failed to file returns or who filed returns but owed more taxes. Although comprehensive data on the revenues collected through this effort have not been systematically tracked, the data collected by some states and IRS districts demonstrate that computer tape exchanges have increased revenues. For example, one state billed taxpayers for $37.5 million in 1990 state income taxes on the basis of data in IRS tapes that showed IRS adjustments to taxpayers’ federal taxes. The state billed those taxpayers who had failed to report and pay additional state income tax due as a result of the federal adjustments. The joint electronic filing effort—which was initiated in 1991 as a limited research test with the South Carolina Tax Commission—is an initiative among IRS and the states to allow taxpayers to simultaneously file state and federal returns electronically. According to IRS, 31 states will participate in the 1996 FedState Electronic Filing program. Electronic returns go to IRS, which then is to send the states their portions of the filing. While no systematic effort has been made to assess the benefits of joint electronic filing, IRS believes that joint filing increases efficiency because it encourages electronic filing and thus eliminates the costs of processing and storing paper returns. Also, according to IRS, electronic filing reduces administrative costs to both IRS and the states because mathematical errors are detected electronically and transcription errors are eliminated. Finally, IRS said that joint electronic filing reduces taxpayer burden by enabling taxpayers to submit their state and federal returns in a single electronic transmission, thus avoiding corresponding mathematical errors. The state refund offset program, also referred to as the State Income Tax Levy Program (SITLP), allows IRS to levy state tax refunds to fulfill federal tax debts. According to IRS, a levy is more efficient than other collection enforcement actions. The program has been in operation since 1985. According to an IRS official, 31 states participated in SITLP, which in 1995 netted IRS $81.7 million in due taxes. To increase the efficiency of its motor fuels compliance efforts, IRS is part of the dyed diesel fuel program, which was established in 1994 and involves sampling fuel in storage and vehicles to ensure that red-dyed fuel, which is tax free, is not used as taxable fuel on highways. According to IRS, 15 states have contracted with IRS to sample and test diesel fuel in vehicles used on highways. IRS believes the program has increased compliance. IRS’ preliminary data indicate that diesel fuel excise tax collections increased by about $1.2 billion, or 22.5 percent, from calendar year 1993 to 1994. In addition to these four common efforts, numerous efforts have been initiated at the IRS district and state levels. For example, IRS and 1 state revenue department conducted a joint video conference seminar linked to 19 locations statewide to inform tax practitioners of changes in the tax laws. IRS and the state hoped this combined video conference would (1) improve taxpayer service by informing a greater number of practitioners in more remote locations and (2) increase efficiency by reducing the amount of time and money IRS and state employees spent traveling to such seminars. Another IRS district and state tax agency targeted a localized group of nonfiling and underreporting self-employed taxpayers.