The following highlights some of the most important steps that IRS has taken to lay the foundation for ultimately providing better service to taxpayers and ensuring compliance with the tax laws. First, during fiscal year 2001, IRS transitioned to a new organizational structure with four divisions having responsibility for administering tax law for a set of taxpayers with similar needs. By reorganizing in this manner, IRS sought to establish clearer lines of responsibility and accountability for improving service to taxpayers and resolving their problems. Through such improvements, IRS expected to better enable taxpayers to comply with the tax laws. Because many major reengineering efforts were to be led by the new divisions, it is too early to judge the impact that the reorganization has had in improving service. The widescale reorganization was accomplished with no serious disruption of recent filing seasons. The filing season for most individual taxpayers extends from January 1st to April 15th. It is during that time when most taxpayers file their returns, call IRS with questions, and make other contacts with IRS related to filing. To its credit, IRS was able to reorganize while managing the challenges associated with the sheer scope of filing season activities, including the year 2000 transition. To make decisions for fiscal year 2002 and subsequent year operations, IRS implemented a new strategic planning, budgeting, and performance management process during fiscal year 2000. The process begins, as outlined in figure 1, with the operating divisions preparing strategic assessments that describe significant trends, issues, and problems and identifies proposals for dealing with them. After receipt and review of the strategic assessments, the commissioner provides detailed guidance (step 2) to the operating divisions for developing their strategy and program plans (step 3). These plans are then incorporated (step 4) into an IRS-wide performance plan (which sets out measurable objectives such as the number of audits to be done). These plans are, in turn, incorporated into IRS’s budget justification (which sets out its resource requests to Congress). The remaining steps (5 and 6) involve allocating resources across IRS divisions and programs and monitoring division adherence to the planning and budgeting decisions. This process provides IRS senior management with a means to reconcile competing priorities with the realities of available resources. Through the use of this process in developing its budget request for fiscal year 2003, IRS identified a myriad of expected efficiency improvements, technological enhancements, labor-saving initiatives, and workload decreases that it projects will enable it to redirect about $158 million (about 2,300 staff positions) to higher-priority areas. This accounted for two out of every three additional staff that IRS believed was needed. In February 2000, IRS implemented a new evaluation system for its managers and in October 2001 implemented a new evaluation system for front-line employees. These systems were developed to structurally align performance expectations for managers and employees with IRS’s strategic goals. An employee evaluation system can be a powerful tool in helping an agency achieve its mission and ensuring employees at every level of the organization are working toward common ends. Evaluation systems should help employees understand their responsibilities and how their day-to-day work contributes toward meeting their agency’s strategic goals as well as providing a mechanism for giving employees candid, specific feedback on how well they are meeting their rater’s expectations. For agencies like the IRS that are undergoing a cultural change, the employee evaluation system helps reinforce behaviors and actions that support the agency’s mission. IRS recognizes that it may take a while before the new evaluation systems achieves the intended results of balancing taxpayer needs while at the same time enforcing the tax laws. These expectations may appear to conflict so managers and employees may need time to better understand what the new performance expectations mean in terms of their daily work and which behaviors they should change in order to put IRS’s new operational environment into practice. IRS has made progress in developing a way to measure the voluntary compliance of individual taxpayers without placing an undue burden on them. Each year billions of dollars in taxes are not voluntarily reported and paid. To understand the overall extent of noncompliance, IRS plans to implement its study of tax reporting compliance later this fall. The study should provide IRS with data to update the criteria it uses to select tax returns for audit and thereby reduce the number of compliant taxpayers selected. Also, the study is intended to provide detailed information about compliance, such as why taxpayers fail to comply with a specific tax law provision. Having such information should enable IRS to make operational changes such as modifying tax forms and instructions or to recommend tax law changes that could improve compliance. Over the past 3-plus years, IRS has made important progress in establishing the infrastructure systems that are to provide the platforms upon which future business applications will run. Establishing this infrastructure is a necessary prerequisite to introducing the business applications that are in turn intended to provide benefits to taxpayers and IRS. During this time, IRS has also made important progress in delivering two system applications—Customer Communications 2001 and Customer Relationship Management Exam—that are producing benefits as of today. For example, Customer Communications 2001, which is software improvements to IRS’s customer service telephone system, was implemented last summer and is now routing taxpayer calls with common questions to automated menu driven information services, thereby freeing IRS customer service representatives to answer complex or less common inquiries. IRS has also made progress in building and readying for deployment, business applications to, among other things, replace existing antiquated information technology systems that have hampered IRS’s ability to improve customer service to taxpayers. In particular, IRS has been building and is planning to pilot in July 2002, the first release of its Customer Account Data Engine (CADE)—a modern relational database designed to replace IRS’s tape-based data management system—for taxpayers with simple tax returns. IRS plans to implement this release in January 2003 in time for the 2003 filing season and plans to implement four additional CADE releases, each for progressively more complex tax returns, over the next 4 years with the goal of having CADE fully implemented by 2006. In addition, IRS has made progress in addressing our recommendations to establish the modernization management controls needed to effectively acquire and implement major systems. For example, we have consistently recommended since 1995 that IRS develop and implement an enterprise architecture (modernization blueprint) to guide and constrain the acquisition of business systems modernization (BSM) systems; IRS recently issued an updated a version of its Enterprise Architecture for how it wants to transition its business systems environment, thus giving a high- level roadmap to manage and control business and technological change. The nature of IRS’s progress thus far should not be viewed solely in the context of what taxpayer service and IRS efficiency benefits are being realized today. Rather, this progress should also be viewed in terms of laying the necessary foundation from which the benefits of future applications can be realized. As a matter of fact, at this point in time, the level of tangible mission-related benefits that have been realized from modernization investments are not yet commensurate with costs incurred. In our view, this is not unreasonable because as depicted in figure 2, the expected return on these and future investments are to materialize later when new business applications are brought on line. For 2 consecutive years, IRS has produced financial statements that present fairly, in all material respects, in conformity with U.S. generally accepted accounting principles, IRS’s assets, liabilities, net position, changes in net position, budgetary resources, reconciliation of net costs to budgetary obligations, and custodial account activity. This unqualified opinion was achieved through the extraordinary efforts of IRS’s senior management and staff to compensate for serious internal control and system deficiencies discussed in the risk section of this statement. Additionally, IRS continues to make progress on several significant internal control and compliance issues that contribute to its difficulties in producing reliable and timely information. IRS faces risks in several areas that if not successfully managed could threaten the agency’s ability to continue making progress modernizing. The first area of risk involves the declines in compliance and collection programs. Taxpayers’ willingness to voluntarily comply with the tax laws depends in part on their confidence that their friends, neighbors, and business competitors are paying their share of taxes. To help provide that assurance, IRS operates six major compliance programs. These programs (1) check for math errors and unpaid balances during returns processing, (2) determine taxes due from apparent nonfilers detected through computer matching, (3) determine taxes due from apparent underreporters detected through computer matching, (4) audit tax returns filed by individuals, (5) audit tax returns filed by corporations, and (6) audit other tax returns such as estate and gift returns. IRS also operates two separate collection programs for dealing with taxpayers who are delinquent in paying the taxes they owe. These programs pursue collection through (1) telephone contacts with the taxpayers and (2) personal visits with the taxpayers by IRS field staff. As part of our ongoing work for the House Ways and Means Subcommittee on Oversight, we identified large and pervasive declines across the compliance and collection programs, except for returns processing, between fiscal years 1996 and 2001. For example, individual and corporate audit productivity as measured by cases closed per unit of staff time declined 31 and 47 percent, respectively, while field and telephone collection productivity declined over 20 percent. These productivity declines coupled with reduced staffing has translated to declines in coverage. That is, the proportion of individual and corporate tax returns that were audited declined 63 and 60 percent, respectively, and the percentage of delinquencies closed by telephone and field collection declined by 15 and 45 percent, respectively. Figures 2, 5 and 6 in the appendix provide additional data. The decline in collection coverage reflected the collection programs’ inability to work a growing proportion of the delinquent cases referred from the compliance programs. In response, by fiscal year 2001, IRS was deferring collection action on about one out of three assigned delinquencies. By the end of fiscal year 2001, we estimate that IRS had deferred collecting taxes from about 1.3 million taxpayers who owed about $16.1 billion. Absent significant operational change, IRS officials said that they had little expectation of reopening many deferred collection cases.