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Title: Internal Revenue Service Issues
Subtitle:
Report No.: GAO/OCG-93-24TR Date: December 1992
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Author: United States General Accounting Office
Office of the Comptroller General
Addressee: Transition Series
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CONTENTS
IRS Issues
Changing the Way Irs Operates
Managing Tax Systems Modernization
Strengthening Human Resources
Supporting the Strategic Business Process
Collecting Back Taxes
Reducing the Tax Gap
- Measuring Compliance
- Enforcement Considerations
- Rethinking the Enforcement Approach
Improving Financial Management
Managing Criminal Investigation Resources
Responding to Calls for a Consumption Tax
Related GAO Products
Transition Series
- Economics
- Management
- Program Areas
Office of the Comptroller General
Washington, DC 20548
December 1992
The Speaker of the House of Representatives
The Majority Leader of the Senate
In response to your request, this transition series report discusses major
policy, management, and program issues facing the Congress and the new
administration in the Internal Revenue Service. The issues include (1)
devising structures, systems, and processes for administering the tax system
in the next century; (2) modernizing computer systems to support redesigned
processes; (3) strengthening human resources; (4) supporting IRS' strategic
business process; (5) reducing the tax gap; (6) improving financial
management; (7) managing criminal investigation resources; and (8) responding
to calls for a consumption tax.
As part of our high-risk series on program areas vulnerable to waste, abuse,
and mismanagement, we are issuing a related report, _Internal Revenue Service
Receivables_ (GAO/HR-93-13, Dec. 1992).
The GAO products upon which this transition series report is based are listed
at the end of this report.
We are also sending copies of this report to the President-elect, the
Republican leadership of the Congress, the appropriate congressional
committees, the Secretary-designate of the Treasury, and the
Commissioner-designate of Internal Revenue.
In our 1988 transition series report on the Internal Revenue Service, (IRS) we
discussed four tax administration issues facing the agency. The most pressing
overall issue then was to modernize IRS' outdated and inefficient tax
processing system. It still is. Nonetheless, IRS has made substantial progress
in the intervening years in addressing the problems discussed in our 1988
report. IRS took steps to alleviate an impending computer capacity problem,
appointed a Chief Information Officer and a Chief Financial Officer to provide
needed leadership, and produced a design plan for the systems modernization
that it periodically updates as new elements of the design take shape. Today
much more work remains to be done to ensure that this project--which is one of
the largest of its kind and is expected to cost $23 billion through the year
2008--is successfully implemented.
The three other issues discussed in our 1988 report remain to be resolved.
Although IRS can point to much work in those areas, the agency still needs to
strengthen human resources, collect $30 billion in delinquent taxes, and
reduce the $114 billion tax gap (the difference between what taxpayers owe and
what they voluntarily pay).
In addition to the four areas noted above, this report discusses five other
areas that will require the new Commissioner's priority attention--ongoing
efforts to change the way IRS does business, the strategic business process,
financial management, management of criminal investigation resources, and the
need to respond to calls for a consumption tax.
Two themes cut across all these issues--the need to foster and manage change
and the need for effective communication in such a large, decentralized
organization.
CHANGING THE WAY IRS OPERATES
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IRS is on the threshold of what could be the agency's most significant change
in decades. IRS staff are at work reassessing the way the agency does
business, reengineering major work processes, and rethinking the traditional
functional and organizational alignment. We have long recommended this
critical step in modernizing the agency. IRS has suffered from a fragmented
organization, inefficient work processes, antiquated systems, and parochial
views of its component work--all of which have frustrated IRS-wide efforts to
improve taxpayers' satisfaction and maximize collections. The new
administration will have to decide what IRS will look like in the next century
and exert strong leadership to implement the needed changes.
The way IRS provides telephone assistance illustrates the agency's
fragmentation. Over the years, in an effort to satisfy taxpayers' demands for
assistance, IRS has established 32 telephone sites in the Taxpayer Service
function to answer tax law and account questions, 23 telephone sites in the
Collection function to handle calls on overdue accounts, and 3 telephone sites
in the Human Resources and Support function to handle calls requesting copies
of tax forms and publications. IRS also handles calls relating to
document-matching issues and other matters at the 10 service centers managed
by its Returns Processing function. As a result of this fragmented
organization, callers seeking help from IRS are asked to use one of dozens of
telephone numbers. When taxpayers call IRS, they are likely to get a busy
signal and, once they get through, often find it necessary to speak to more
than one person before getting the information they need.
IRS is now exploring the feasibility of consolidating its telephone sites and
designating a common or single telephone number for taxpayer assistance
nationwide. To really streamline its telephone service to taxpayers, IRS must
look at having a single organization responsible for uniformly measured
telephone service and organized to respond to taxpayers' questions in a way
that reduces anxiety and eliminates the need for time-consuming, laborious
written correspondence. Because taxpayers deserve from IRS the same level and
caliber of service that they receive from world-class financial institutions,
IRS must be able to give taxpayers accurate information with minimal delay.
MANAGING TAX SYSTEMS MODERNIZATION
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Central to any change in the way IRS does business is Tax Systems
Modernization (TSM)--the redesign of automated systems so critical to IRS'
work. To provide the type of service taxpayers deserve, IRS must make taxpayer
information quickly available to every employee who needs it. Recent IRS
Commissioners, recognizing how important computer modernization is to tax
administration, have built on their predecessors' efforts to bring TSM to
fruition. This should be no less of a priority for the new Commissioner.
With an estimated cost of about $23 billion through the year 2008, TSM is
perhaps the largest civilian computer modernization in history. IRS has
developed a basic design concept for the modernization, but that technical
design was developed before IRS had thoroughly reassessed its basic business
processes. The details of the technical design may have to change to support
the new vision of IRS. In that regard, the new Commissioner will need to give
priority attention to the following:
-- Finalize an operational strategy soon. Too many other decisions hinge on
this one, and dollars may be wasted if IRS does not reach closure on this
issue.
-- Once an operational strategy has been finalized, verify that major
procurements proceeding from the technical design fit the needs of the new
operating environment. Contracts for several of these procurements have
been awarded, and others are about to be. It is important to act quickly in
order to avoid wasteful spending, even if this means putting the brakes on
certain TSM initiatives.
-- Give top priority to making on-line access to taxpayer information
available to every IRS employee who needs to work with that information.
Make that happen first and soon by putting the taxpayer file on-line to
every workstation and implementing the kind of telecommunication network
that can send this information anywhere, anytime. The new workstations and
telecommunication networks put in place must be capable of handling
features such as image, fax, and high-volume data transactions, even though
those applications are not yet ready.
Because TSM is so large, it is expected to take more than a decade to
complete. Getting the budgetary support and the right people to manage it will
be a long-term concern. To avoid the kinds of project delays and procurement
problems that have arisen in the past, IRS needs experienced senior and
project managers to oversee and direct TSM. These managers must have technical
expertise as well as management acumen and commitment to deliver results
within agreed upon time frames.
Throughout the TSM initiative, IRS needs to ensure that its systems designs
will produce good management information. Perhaps the most consistent theme
over the past 2 decades of GAO reports is how often IRS managers do not have
the right information to do their jobs. One significant effort to improve
management information that needs continuing emphasis is the work being done
to implement the Enforcement Management Information System. That system, when
fully implemented, should provide management and the Congress with much needed
information on the actual results and costs of IRS' enforcement efforts.
STRENGTHENING HUMAN RESOURCES
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The changes that are sure to come as IRS redesigns the way it does business
will transform the agency into one that depends less on manual labor and more
on technology-based skills. The technical implications of modernization have
received most of the emphasis in IRS. It is critical that IRS also pay
attention to the significant human resource implications. IRS must develop
human resource strategies that support the new business direction and
technical environment. As part of that effort, IRS needs to determine
workforce levels, reassess skill needs, identify strategies for meeting those
needs, and manage workforce adjustments.
Fulfilling IRS' policy of protecting employees' jobs from
modernization-generated staff reductions will be a formidable challenge. IRS
must bridge the gap between existing workforce skills and abilities and those
that will be needed in the modernized environment. By planning far enough in
advance and using the intervening years for training, IRS should be better
able to meet that challenge. IRS has taken a critical step toward that end by
recently drafting a much needed human resources plan. The new Commissioner
will need to ensure that aggressive action is taken to implement that plan.
Another critical human resource issue facing the new Commissioner relates to
employee ethics and integrity. IRS' record in this area has come under
increasing scrutiny. IRS must continue vigorous efforts to promote open
communication, strengthen employee awareness, and increase managerial
accountability. IRS employees must recognize and accept the fact that they
will be held to a high ethical standard to protect the integrity of this
country's voluntary tax system.
SUPPORTING THE STRATEGIC BUSINESS PROCESS
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IRS is building a strategic business process that could serve as a model for
other federal agencies. The cornerstone of that process is a strategic plan,
which is updated annually. As part of that plan, IRS has identified three
broad business objectives--improving voluntary compliance, reducing taxpayer
burden, and improving quality-driven productivity and customer
satisfaction--and various strategies and actions to help IRS achieve those
objectives. Annual plans are developed to guide headquarters and field office
activities in support of the business plan, and annual business reviews are
done to assess progress.
If IRS' strategic business process is to be effective, it is critical that IRS
develop appropriate performance measures. Without the right measures, IRS will
be unable to assess progress in achieving its business goals. The measures IRS
now uses are focused largely on processes rather than outcomes. For example,
IRS tracks the number of auditors and audits completed but does not track the
effect of audits on voluntary compliance. IRS recognizes the need for better
measures and has efforts under way in that regard. The new Commissioner needs
to lead those efforts and to hold managers accountable for meeting outcome
goals. Because IRS is so decentralized, holding managers accountable for
agency goals is critical to IRS' operating with a shared understanding of its
mission and direction.
COLLECTING BACK TAXES
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The new administration will have to give continuing priority attention to the
collection of taxes owed the government. In general, IRS has reported accounts
receivable that are significantly higher than could ever be collected; IRS
itself estimated that less than $30 billion of 1991's $111 billion inventory
was collectible. Yet because IRS does not know how many records are valid, no
one really knows the true number of receivables, much less how many of them
are collectible. In a separate high-risk report on IRS receivables, we discuss
the steps needed to better manage this area--1 of 17 throughout the government
designated by us as high risk.
That report discusses several problems that have interfered with IRS' ability
to collect unpaid taxes, including (1) inaccurate and insufficient IRS
records; (2) a lengthy, antiquated, rigid, and inefficient collection process;
(3) difficulty in balancing collection efforts with the need to protect the
taxpayer; (4) IRS' decentralized structure; and (5) inadequate information on
how to allocate staff effectively. The report also summarizes our various
recommendations for improvement.
REDUCING THE TAX GAP
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IRS has estimated the tax gap for 1992 to be about $114 billion. That estimate
is conservative because it only relates to income taxes and excludes taxes
associated with illegal-source income. In an attempt to reduce the tax gap,
IRS recently announced a goal to increase voluntary compliance with the tax
laws from 84 percent to 94 percent in 8 to 10 years. To achieve that goal,
important decisions will have to be made on research efforts, enforcement
programs, and resource allocations. Those decisions need to be made
cohesively, in ways most likely to improve overall compliance. The time is
also right, as IRS goes about changing the way it does business, to rethink
its entire approach to enforcement.
An early decision facing the new Commissioner will involve the design of next
year's Taxpayer Compliance Measurement Program (TCMP)--the only reliable
measure of compliance and a program that provides data used in tax policy
decisions, revenue estimating, and estimation of U.S. income accounts. The
current direction appears to be toward eventual elimination of TCMP on the
grounds it is too costly, too intrusive, and untimely. We believe that would
be a mistake. TCMP needs to be fixed, not eliminated. TCMP is critical to IRS
and the whole tax community. It should provide an important outcome measure
for IRS' strategic business process, enough information to make informed
decisions on enforcement program and resource allocations, and sufficient data
for tax policy decisions.
TCMP did not provide an empirical base for IRS' latest enforcement
strategy--Compliance 2000. Instead, IRS launched Compliance 2000 by asking the
63 district offices to nominate "taxpayer segments" as prototypes. Because
TCMP has not provided estimates at that disaggregated a level, prototype
selection necessarily depended on judgments. Thus, IRS has no assurance that
it is working on the most noncompliant segments or that prototype
results--however positive--will improve overall compliance levels. Had it
relied on TCMP data that were valid at the regional office level, IRS would
have had a firmer foundation from which to launch Compliance 2000.
Under Compliance 2000, more emphasis is being placed on the role of taxpayer
education and assistance in improving compliance and reducing the tax gap.
Even so, enforcement is still critical. Audit coverage, a key indicator of the
level of IRS' enforcement effort, has shown a disturbing trend in the past few
years. Overall coverage is only about 1 percent, and the coverage of
corporations decreased from 5 percent in 1981 to less than 3 percent in 1991.
Faced with this declining audit presence, the new Commissioner needs to
determine
-- the role of audits and the proper balance between auditing returns, doing
computer matches, and tracking down nonfilers;
-- acceptable audit coverage rates and whether those rates should be at
similar levels around the country;
-- the proper balance of coverage among corporate, individual, partnership,
and other types of returns;
-- whether audit quality is high enough and how quality should be measured;
and
-- whether and how IRS' traditional approach to doing audits should be changed
to better serve both IRS and taxpayers.
Such issues are particularly pertinent with respect to the largest
corporations--those 1,600 now covered by IRS' Coordinated Examination Program.
Of continuing concern is IRS' capacity to collect the right amount of tax from
these highly complex corporations. Much of the additional taxes recommended
from IRS audits is not billed to the corporations after the appeals process.
IRS has made changes in the last 2 years to better manage this program. In a
forthcoming report, we will discuss more fundamental changes that may be
warranted.
The new administration will also need to deal with various audit issues that
recur time and time again, consuming significant IRS resources, often without
realizing for the government the additional revenues proposed by its
examiners. Audits of large multinational corporations, for example, are beset
by transfer pricing issues that involve deciding whether related corporate
entities have calculated correctly the arm's-length price for goods brought
into or taken out of the United States. The Congress has legislated some
changes in an attempt to deal with certain troublesome audit issues, and IRS
has made other changes administratively, but the problem is likely to persist
with the globalization of trade.
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RETHINKING THE ENFORCEMENT APPROACH
Given intractable issues such as transfer pricing, worrisome compliance levels
for some segments of taxpayers, and continuing resource constraints, it is a
good time for IRS to rethink its enforcement approaches. Following are several
questions the new Commissioner needs to ask:
-- How could the design of the tax system be changed to produce higher
compliance levels?
-- Is there a need for more withholding at the source, incentives for cash
businesses, or simplified ways to file returns and pay taxes?
-- Does everyone have to file a tax return?
-- Are there more opportunities to improve compliance through additional
information reporting or increased information sharing among governmental
entities?
-- How could compliance checks be designed into TSM?
-- Is IRS using the right enforcement tools at the right time?
IRS has determined that in order to achieve its three broad business
objectives it needs, among other things, a strong financial management system.
As discussed in our transition series report _Financial Management Issues_
(GAO/OCG-93-4TR, Dec. 1992), IRS, like other federal agencies, has serious
financial management weaknesses.
IRS' financial management systems were generally designed to track information
on identified program objectives and were not integrated to ensure that
agencywide activity was fully captured and reported. As a result, IRS is
unable to accurately segregate and substantiate tax revenues collected and the
related accounts receivable. For example, IRS cannot reliably identify the
amount of taxes collected for Social Security or any of the trust funds for
which IRS collects excise taxes. Also, IRS cannot identify the actual amount
of accounts receivable because a large number of invalid accounts and errors
are contained in the financial management systems used to track receivables.
IRS' ability to identify program costs is also significantly impaired. This
limitation minimizes the agency's ability to properly evaluate program
performance and identify needs. In addition, financial management weaknesses
have resulted in accounting and control problems over assets and spending.
As the new administration seeks to reduce the budget deficit and improve
federal agencies' performance, it will be important for the Commissioner of
Internal Revenue to give urgent focus to converting these ineffective and
often outdated financial management systems to systems that will provide
accurate and reliable financial information for use in policymaking and other
decisions that affect American taxpayers.
The Chief Financial Officers (CFO) Act of 1990, which represents the most
comprehensive financial reform package in 40 years, provides a blueprint for
change that, if fully implemented, would enable IRS to correct its financial
management systems problems. Over the past 2 years, IRS has made important
strides in establishing a CFO structure and in beginning to implement the full
range of requirements in the CFO Act. But the process of change under the CFO
Act has just begun.
Sustained support and top-level attention by the new administration, IRS, and
the Congress is needed to build on the efforts now under way at IRS to improve
financial management through implementation of the CFO Act. The tone at the
top will be critical to ensuring meaningful reform. As discussed in greater
detail in our transition series report on financial management issues, among
the key actions are the need to
-- make clear that financial management reform is a continuing high priority
and hold managers accountable for results;
-- expand the role of the CFO to encompass the full range of duties and
authorities in the CFO Act;
-- promote and closely oversee efforts to build first-class financial
management infrastructures--both people and systems;
-- emphasize the development of cost systems and performance measures and the
integration of accounting, program, and budget systems to develop more
useful and relevant financial information; and
-- foster continuing efforts to develop auditable financial statements and to
expand financial reporting to encompass the full range of accountability
contemplated by the CFO Act and the Office of Management and Budget's
implementing guidance.
The new Commissioner will be faced with competing priorities for IRS' criminal
investigation work. Other law enforcement agencies seek the financial
expertise of IRS' special agents for cases that increasingly involve
sophisticated financial transactions. This leaves IRS fewer resources to
investigate criminal violations of the tax law. During congressional
deliberations on the administration's fiscal year 1993 budget request for IRS,
the criminal investigation area came under considerable scrutiny.
The Senate passed a provision, for example, that would have changed IRS'
organization by providing the Assistant Commissioner for Criminal
Investigation with direct line authority over tax fraud investigations.
Although that provision was defeated in conference, IRS has been directed to
study the Criminal Investigation Division to determine whether it is
adequately funded and staffed.
The new Commissioner will also have to be concerned about the adequacy of
controls over IRS' special agents. IRS is working to implement several of our
recommendations for strengthening controls over one particular
technique--undercover investigations.
RESPONDING TO CALLS FOR A CONSUMPTION TAX
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More groups this year than ever before have proposed that the United States
adopt some type of consumption tax. For example, the first report of the
Strengthening of America Commission, chaired by Senators Sam Nunn and Pete
Domenici, proposed a consumption-based income tax. While IRS will not have to
decide whether there should be such a tax, IRS will need to advise
policymakers of its implications.
One important consideration is whether the proposed tax would be a
fundamentally new federal level tax, such as a value-added or retail sales
tax, or a variant of existing taxes, such as a cash-flow business tax or a
personal expenditure tax. A new tax would potentially require a new
enforcement approach with additional administrative resources. A variant of
existing taxes, while presenting new and difficult enforcement challenges,
might be more easily managed within existing approaches and resources. In any
form, such a tax would have great ramifications for IRS. IRS needs to be in a
position to quickly analyze how it would administer the various forms of such
a tax that may be proposed. In that regard, we will report in several months
on how a value-added tax would be administered and how much it would probably
cost to administer it.
