Productivity is defined as the efficiency with which inputs are used to produce outputs. It is measured as the ratio of outputs to inputs. Productivity and cost are inversely related—as productivity increases, average costs decrease. Consequently, information about productivity can inform budget debates as a factor that explains the level or changes in the cost of carrying out different types of activities. Improvements in productivity either allow more of an activity to be carried out at the same cost or the same level of activity to be carried out at a lower cost. IRS currently relies on output-to-input ratios such as cases closed per FTE to measure productivity and productivity indexes. A productivity change is measured as an index which compares productivity in a given year to productivity in a base year. Measuring productivity trends requires choosing both output and input measures, and the methods for calculating productivity indexes. In the past we have reported on declining enforcement trends, finding in 2002 that there were large and pervasive declines in six of eight major compliance and collection programs we reviewed. In addition to reporting these declines, we reported on the large and growing gap between collection workload and collection work completed and the resultant increase in the number of cases where IRS has deferred collection action on delinquent accounts. In 2003, we reported on the declining percentage of individual income tax returns that IRS was able to examine or audit each year, with this rate falling from 0.92 percent to 0.57 percent between 1993 and 2002. Since 2000, the audit rate has increased slightly but not returned to previous levels. IRS conducts two types of audits: field exams that involve complex tax issues and usually face-to-face contact with the taxpayer, and, correspondence exams that cover simpler issues and are done through the mail. We also reported on enforcement productivity measured by cases closed per FTE employee, finding that IRS’s telephone and field collection productivity declined by about 25 percent from 1996 through 2001 and productivity in IRS’s three exam programs—individual, corporate, and other audit—declined by 31 to 48 percent. In January 2004 we reported on the extent to which IRS’s Small Business and Self-Employed (SB/SE) division followed steps consistent with both GAO guidance and the experience of private sector and government organizations when planning its enforcement process improvement projects. We reported on how the use of a framework would increase the likelihood that projects target the right processes for improvement and lead to the most fruitful improvements. In that report, we also reported that more complete productivity data—input and output measures adjusted for the complexity and quality of cases worked—would give SB/SE managers a more informed basis for decisions on how to identify processes that need improvement, improve processes, and assess the success of process improvement efforts. This report elaborates on that recommendation, providing more information about the challenges of obtaining complete productivity data. Improving productivity by changing processes is a strategy SB/SE is using to address these declining trends. However, the data available to SB/SE managers to assess the productivity of their enforcement activities, identify processes that need improvement, and assess the success of their process improvement efforts are only partially adjusted for complexity and quality of cases worked. This problem of adjusting for quality and complexity is not unique to SB/SE process improvement projects—the data available to process improvement project managers are the same data used throughout SB/SE to measure productivity and otherwise manage enforcement operations. Because IRS provides services, such as providing information to taxpayers and enforcing the tax laws, that are intangible and complex, measuring output—and therefore productivity—is challenging. Like other providers of intangible and complex services, IRS has a choice of measuring activities or the results of its services. Generally, information about results is preferred, but measuring results is often difficult. In the absence of direct measures of results, activities that are closely related to the results of the service can be used as proxies. Measuring productivity in services is difficult. Unlike manufacturing, which lends itself to objective measurement because output can be measured in terms of units produced, services, which involve changes in the condition of people receiving the service, often have intangible characteristics. Thus, the output of an assembly line is easier to measure than the output of a teacher, doctor, or lawyer. Services may also be complex bundles of individual services, making it difficult to specify the different elements of the service. For example, financial services provide a range of individual services, such as financial advice, accounts management and processing, and facilitating financial transactions. IRS provides a service. IRS’s mission, to help taxpayers understand and meet their tax responsibilities and to apply the tax law with integrity and fairness, requires IRS to provide a variety of services ranging from collecting taxes to taxpayer education. IRS, like other service providers, could measure output in terms of its results—its impact on taxpayers—or in terms of activities. The results of IRS’s service are the impacts on the condition or behavior of taxpayers. These taxpayer conditions or behaviors include their compliance with the tax laws, their compliance burden (the time and money cost of complying with tax laws), and their perception of how fairly taxpayers are treated. IRS’s activities are what IRS does to achieve those results. These activities include phone calls answered, notices sent to taxpayers, and exams conducted. Generally, information about results is preferred, but measuring such results is often difficult. In the case of the public sector, this preference is reflected in GPRA, which requires that federal agencies measure performance, whenever possible, in terms of results or outcomes for people receiving the agencies’ services. However, results such as compliance and fairness have intangible characteristics that are difficult to measure. In addition, results are produced in complicated and interrelated ways. For example, a transaction or activity may affect a number of results: IRS’s exams may affect taxpayers’ compliance, compliance burden, and perceptions of the fairness of the tax system. In addition, a result may be influenced by a number of transactions or activities: A taxpayer’s compliance may be influenced by all IRS exams (through their effect on the probability of an exam) as well as by other IRS activities such as taxpayer assistance services. IRS’s activities are easier to measure than results but still present challenges. Activities are easier to measure because they are often service transactions such as exams, levies issued, or calls answered that can be easily counted. However, unlike measures of results, more informative measurement of activities requires that they be adjusted for quality and complexity, as we noted in our report on IRS’s enforcement and improvement projects. A productivity measure based on activities such as cases closed per FTE may be misleading if such adjustments are not made. For example, an increase in exam cases closed per FTE would not indicate an increase in true productivity if the increase occurred because FTEs were shifted to less complex cases or the examiner allowed the quality of the case review to decline to close cases more quickly. Activities-based productivity measures can provide IRS with useful information on the efficiency of IRS operations. Measuring output, and therefore productivity, in terms of activities provides IRS with measures of how efficiently it is using resources to perform specific functions or transactions. However, activities do not constitute—and should not be mistaken for—measures of IRS’s productivity in terms of ultimate results. While the productivity measures we have examined are based on activities, IRS has efforts under way to measure results such as compliance and compliance burden. Recently, we reported on IRS’s National Research Program (NRP) to measure voluntary compliance and efforts to measure compliance burden. As we mentioned previously, measuring these results is difficult. For some results, such as compliance, measurement is also costly and intrusive because taxpayers must be contacted and questioned in detail. Despite these difficulties, IRS can improve its productivity measurement by continuing its efforts to get measures of results. These efforts would give Congress and the general public a better idea of what is being achieved by the resources invested in IRS. In the absence of direct measures of results, activities that are closely related to the results of the service are used as proxies. The value of these proxies depends on the extent to which they are correlated with results. By carefully choosing these measures, IRS may gain some information about the effect of its activities on ultimate results. Because activities may affect a number of results and a single result may be affected by a number of activities, a single activity likely will not be a sufficient proxy for the results of the service. Therefore, a variety of activities would likely be necessary as proxies for the results of the service. Both types of output measures, those that reflect the results of IRS’s service and those that use activities to measure internal efficiency, should be accurate and consistent over time. In addition, both output measures should be reliably linked to inputs. Linking the results of IRS’s service to inputs may be difficult because of outside factors that may also affect measured results. For example, an increase in compliance could result both from IRS actions such as exams and from changes in tax laws. Another challenge is that IRS currently has difficulties linking inputs to activities, as we note in a previous report, where we reported IRS’s lack of a cost accounting system. In particular, IRS only recently implemented a cost accounting system, and has not yet determined the full range of its cost information needs. Table 1 summarizes some of the key differences between activities and results measures. Table 1 also indicates some general criteria that apply to both types of measures. Because inputs are more easily measured and identifiable than outputs, measuring them is more straightforward. IRS, as a government agency, may be able more often to use labor costs or hours as a single input in its productivity measures because it relies heavily on labor. However, it may be particularly important for IRS to use a multifactor measure that includes capital along with labor during periods of modernization that involve increased or high levels of capital investment. As with outputs, inputs should be measured accurately and consistently over time.