Compliance and Collection
Challenges for IRS in Reversing Trends and Implementing New Initiatives Gao ID: GAO-03-732T May 7, 2003Taxpayers' willingness to voluntarily comply with tax laws depends in part on their confidence that friends, neighbors, and business competitors are paying their fair share of taxes. The Internal Revenue Service's (IRS) programs to ensure compliance and to collect delinquent taxes are viewed by many as critical for maintaining the public's confidence in our tax system. Congress asked GAO to present information on trends in IRS's compliance and collection programs and to discuss issues related to IRS's efforts to increase staffing for these programs. GAO was also asked to discuss IRS's plans to launch new initiatives to reduce noncompliance with the Earned Income Tax Credit (EIC) and to use private collection agencies to assist in collecting delinquent taxes.
From fiscal years 1993 through 2002, IRS's four major compliance programs for individual taxpayers had mixed trends in the portion of taxpayers they contacted with two declining, one increasing, and one staying relatively the same. Among the programs, IRS's often-cited audit rate declined about 38 percent. From fiscal years 1996 through 2001, IRS's collection program experienced almost universal declines in workload coverage, cases closed, direct staff time used, productivity, and dollars of unpaid taxes collected. Many parties have expressed concern about the compliance--especially audit--and collections trends for their potential to undermine taxpayers' motivation to fulfill their tax obligations. Since 2001 IRS has sought more resources including increased staffing for compliance and collections. Despite receiving requested budget increases, staffing levels in key occupations were lower in 2002 than in 2000. These declines occurred for reasons such as unbudgeted expenses consuming budget increases and other operational workload increases. Based on past experience and uncertainty regarding some expected internal savings, fiscal year 2004 anticipated staff increases might not fully materialize. IRS's 2004 budget proposes a substantial initiative to address known sources of EIC noncompliance. IRS intends to ramp up the initiative rapidly with planning and implementation proceeding simultaneously. If it is to succeed, the initiative will require careful planning and close management attention. IRS also proposes to use private collection agencies to assist in collecting certain delinquent tax debt. IRS is seeking authority to retain some tax receipts in a revolving fund to pay the private collectors. A pilot effort to use private collectors in 1996 was unsuccessful, in part because IRS was unable to identify and channel appropriate collection cases to the private collectors. Key implementation details for this proposal must be worked out and it too will require careful planning and close management attention.
GAO-03-732T, Compliance and Collection: Challenges for IRS in Reversing Trends and Implementing New Initiatives
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Testimony :
Before the Subcommittee on Transportation, Treasury, and Independent
Agencies, Committee on Appropriations, House of Representatives:
For Release on Delivery
Expected at 2 p.m. EDT
Wednesday, May 7, 2003:
COMPLIANCE AND COLLECTION:
Challenges for IRS in Reversing Trends and Implementing New
Initiatives:
Statement of Michael Brostek, Director
Strategic Issues:
GAO-03-732T:
GAO Highlights:
Highlights of GAO-03-732T, a testimony before the Subcommittee on
Transportation, Treasury, and Independent Agencies, Committee on
Appropriations, House of Representatives
Why GAO Did This Study:
Taxpayers‘ willingness to voluntarily comply with tax laws depends in
part on their confidence that friends, neighbors, and business
competitors are paying their fair share of taxes. The Internal Revenue
Service‘s (IRS) programs to ensure compliance and to collect delinquent
taxes are viewed by many as critical for maintaining the public‘s
confidence in our tax system.
The Subcommittee asked GAO to present information on trends in IRS‘s
compliance and collection programs and to discuss issues related to
IRS‘s efforts to increase staffing for these programs. GAO was also
asked to discuss IRS‘s plans to launch new initiatives to reduce
noncompliance with the Earned Income Tax Credit (EIC) and to use
private collection agencies to assist in collecting delinquent taxes.
What GAO Found:
From fiscal years 1993 through 2002, IRS‘s four major compliance
programs for individual taxpayers had mixed trends in the portion of
taxpayers they contacted with two declining, one increasing, and one
staying relatively the same. Among the programs, IRS‘s often-cited
audit rate declined about 38 percent. From fiscal years 1996 through
2001, IRS‘s collection program experienced almost universal declines in
workload coverage, cases closed, direct staff time used, productivity,
and dollars of unpaid taxes collected. Many parties have expressed
concern about the compliance”especially audit”and collections trends
for their potential to undermine taxpayers‘ motivation to fulfill their
tax obligations.
Since 2001 IRS has sought more resources including increased staffing
for compliance and collections. Despite receiving requested budget
increases, staffing levels in key occupations were lower in 2002 than
in 2000. These declines occurred for reasons such as unbudgeted
expenses consuming budget increases and other operational workload
increases. Based on past experience and uncertainty regarding some
expected internal savings, fiscal year 2004 anticipated staff increases
might not fully materialize.
IRS‘s 2004 budget proposes a substantial initiative to address known
sources of EIC noncompliance. IRS intends to ramp up the initiative
rapidly with planning and implementation proceeding simultaneously.
If it is to succeed, the initiative will require careful planning and
close management attention.
IRS also proposes to use private collection agencies to assist in
collecting certain delinquent tax debt. IRS is seeking authority to
retain some tax receipts in a revolving fund to pay the private
collectors. A pilot effort to use private collectors in 1996 was
unsuccessful, in part because IRS was unable to identify and channel
appropriate collection cases to the private collectors. Key
implementation details for this proposal must be worked out and it too
will require careful planning and close management attention.
What GAO Recommends:
GAO is not making any recommendations. GAO is currently working with
members of Congress to define the scope of work they would like GAO to
do to assess IRS‘s proposed initiative to address EIC noncompliance.
www.gao.gov/cgi-bin/getrpt?GAO-03-732T.
To view the full report, including the scope
and methodology, click on the link above.
For more information, contact Michael Brostek at (202) 512-9110 or
brostekm@gao.gov.
[End of section]
Mr. Chairman and Members of the Subcommittee:
I am pleased to participate in the Subcommittee's hearing today
focusing on compliance issues and initiatives in the Internal Revenue
Service's (IRS) fiscal year 2004 budget request. Specifically, my
statement today will cover recent trends in IRS's compliance and
collection programs, IRS's staffing for these programs, and its
initiatives to expand compliance efforts for the Earned Income Credit
(EIC) and to use private collection agencies to assist in the
collection of delinquent tax debt.
From fiscal years 1993 through 2002, IRS's compliance programs for
individual taxpayers--audits, document matching, nonfiler
identification, and math error corrections--had mixed trends in the
rate at which they contact potentially noncompliant taxpayers with two
declining, one increasing, and one staying relatively the
same.[Footnote 1] Among the four programs, IRS's often-cited audit rate
declined approximately 38 percent comparing 1993 to 2002. In the
collection area, comparing fiscal years 1996 to 2001 IRS's collection
program experienced almost universal declines in workload coverage,
cases closed, direct staff time used, productivity, and dollars of
unpaid taxes collected.[Footnote 2] Many parties have expressed concern
about the compliance program--especially audit--and collection program
trends for their potential to undermine taxpayers' motivation to
fulfill their tax obligations.
Concerned about these trends, IRS has sought additional resources,
including increased staffing levels for compliance and collection since
fiscal year 2001. However, despite receiving requested budget
increases, staffing levels in key occupations were lower in 2002 than
in 2000. Reasons for this decline include unbudgeted expenses consuming
budget increases and workload increases in other essential operations.
The 2004 budget again proposes funding increases in part to augment
staffing for compliance and collection activities. Also, as it did last
year, IRS projects that savings from more efficient operations will
enable it to shift more staffing into these activities in 2004. Current
savings projections since the budget was prepared, as well as the past
history of unrealized staffing increases, raise questions about whether
IRS will realize the full staffing increases it expects.
In the compliance area, IRS's 2004 budget proposes a new initiative to
address noncompliance in the EIC. The EIC initiative is a substantial
new effort to target known sources of EIC noncompliance that IRS
intends to ramp up rapidly. Planning and implementation for this
initiative will proceed simultaneously. The success of the initiative
will depend on careful planning and close management attention as IRS's
implementation progresses.
In the collection area, IRS has proposed using private collection
agencies to assist it with a portion of the collection activities for
some delinquent tax debt. IRS is requesting authority to retain some
tax collection receipts in a revolving fund that would be used to pay
the private collectors. A pilot effort to use private debt collectors
in 1996 was unsuccessful, in part because IRS was unable to identify
and channel appropriate collection cases to the private debt
collectors. Various key details for implementing this proposal must be
worked out and it, like the EIC initiative, will require careful
planning and close management attention if Congress authorizes the
effort.
Our assessment of IRS compliance and collection trends, and budget
issues is based on recently issued GAO products. We updated certain
trends for IRS's fiscal year 2002 operations by analyzing IRS
management reports. We also used data reported by the Treasury
Inspector General for Tax Administration. To assess the status of IRS's
EIC initiative and plans to use the assistance of private collection
agencies, we interviewed IRS officials and reviewed documents prepared
to justify both initiatives.
I will now discuss these issues in more detail, turning first to trends
in IRS's compliance and collection programs.
Trends in Compliance and Collection Programs Have Triggered Concern:
In recent years, steep declines have occurred in some of IRS's
compliance programs for individual taxpayers, as have broad declines in
its efforts to collect delinquent taxes. These trends have triggered
concerns that taxpayers' motivation to voluntarily comply with their
tax obligations could be adversely affected.
Compliance Trends Are Mixed; the Often Cited Audit Rate Has Declined
Steeply:
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 fair share of taxes. IRS's compliance
programs, including audits, document matching, and other efforts, are
viewed by many as critical to maintaining the public's confidence in
our tax system.
Looking across all four of IRS's major enforcement programs between
fiscal years 1993 and 2002 reveals a somewhat mixed picture, as shown
in figure 1. The four programs and their trends are as follows:
* The math error program that identifies obvious errors such as
mathematical errors, omitted data, or other inconsistencies on the
filed tax return. Using only the math error count, which is consistent
throughout the 10 years, the math error contact rate rose 33 percent
(from 3.59 to 4.79 percent).
* The document matching program that identifies unreported income using
information returns filed by third parties such as employers and banks.
Document matching rates went up and down at various times but ended 45
percent lower (from 2.37 percent to 1.30 percent) in 2002 compared to
1993.
* The nonfiler program that identifies potential nonfilers of tax
returns by using information return and historical filing data. The
nonfiler rates also went up and down but ended in 2002 about where they
were in 1993.
* The audit program that checks compliance in reporting income,
deductions, credits and other issues on tax returns through
correspondence or in face-to-face meetings with an IRS auditor.
Comparing 1993 to 2002, the audit contact rate dropped 38 percent (from
0.92 to 0.57 percent) even though it rose significantly between 1993
and 1995.
Figure 1: IRS Compliance Contact Rates, Fiscal Years 1993-2002:
[See PDF for image]
Note: The revised math error contact rate includes roughly 2 million
contacts that IRS had been making but had not been reporting as math
errors for fiscal years 1997 through 2002. IRS had not collected data
on these math errors prior to fiscal year 1997.
[End of figure]
Figure 2 shows compliance program trends based on income ranges.
Although audit rates for individual taxpayers in higher and middle-
income ranges rose slightly in 2002, overall they were significantly
lower in 2002 than in 1993, while the rate for the lowest income range
was virtually the same in 2002 as in 1993. The audit contact rates for
the highest and lowest income individuals essentially converged at
around .8 percent in fiscal years 2001 and 2002. Most of the audits of
the lowest income individuals dealt with EIC claims. Document matching
contact for all three income ranges rose somewhat between 2001 and
2002. However, rates for all three income ranges ended significantly
lower in 2002 than 1993 following similar patterns of change over the
years. Data on contact rates by income level were not available for the
math error and nonfiler programs.
Figure 2: IRS Individual Audit and Document Matching Contact Rates by
Income Level, Fiscal Years 1993-2002:
[See PDF for image]
[End of figure]
Collection Trends Have Declined:
As we reported in May 2002, between fiscal years 1996 and 2001 trends
in the collection of delinquent taxes showed almost universal declines
in collection program performance, in terms of coverage of workload,
cases closed, direct staff time used, productivity, and dollar of
unpaid taxes collected.[Footnote 3] Although IRS's workload generally
declined for two of those indicators, workload and cases closed, the
collection work it completed declined more rapidly creating an
increasing gap as show in figure 3.[Footnote 4] During that 6-year
period, the gap between the new collection workload and collection
cases closed grew at an average annual rate of about 31 percent.
Figure 3: Percentage Gap between Collection Workload and Work
Completed, Fiscal Years 1996-2002:
[See PDF for image]
[End of figure]
The increasing gap between collection workload and collection work
completed led IRS in March 1999 to start deferring collection action on
billions of dollars in delinquencies. IRS's inventory of delinquent
accounts was growing and aging and the gap between its workload and
capacity to complete work was increasing. Officials recognized that
they could not work all collection cases, and they believed that they
needed to be able to deal with taxpayers more quickly, particularly
taxpayers who were still in business and owed employment
taxes.[Footnote 5]
By the end of fiscal year 2002, after the deferral policy had been in
place for about 3 and one-half years, IRS had deferred taking
collection action on about $15 billion in unpaid taxes, interest, and
penalties. IRS' deferral of collection action has declined somewhat
since the deferral policy was adopted. Although the rate has declined
from 45 percent in 2000 to about 32 percent in 2002, IRS is still
deferring collection action on about one out of three collection cases.
Concerns Regarding the Compliance and Collection Trends:
Many parties have expressed concern about these trends in IRS's
compliance and collection programs. Since the mid-1990s, we have issued
six reports on IRS compliance and collection trends in response to
congressional concerns.[Footnote 6] During annual oversight hearings on
IRS, Congress often raises questions about the declining audit rate and
possible effects on compliance. In recent years, congressional concerns
as well as IRS's requests have resulted in efforts to augment IRS's
staffing levels.
In fact, the former IRS Commissioner's report to the IRS Oversight
Board during September 2002 made what was perhaps the most explicit
case for additional staffing to address IRS's compliance and collection
performance. Although the Commissioner recognized that IRS needed to
improve the productive use of its current resources, he cited a need
for an annual 2 percent staffing increase on top of planned
productivity increases over 5 years to help reverse the trends. In
terms of the collection of tax debts, the IRS Commissioner estimated
that an almost 60 percent gap exists between IRS's collection workload
and the work it has completed. Closing this gap, according to the
Commissioner, would require 5,450 new full-time staff.[Footnote 7] IRS
also has been looking for ways to free resources for compliance
programs by boosting productivity or reducing workload in other areas.
In our recent Performance and Accountability Series report on the
Treasury Department, we cite the collection of unpaid taxes as one of
the management challenges facing IRS.[Footnote 8] In that report, we
state that IRS is in various stages of planning and implementing
management improvements, including reengineering compliance and
collection practices. However, as of September 30, 2002, IRS's
inventory of known unpaid taxes totaled
$249 billion, of which $112 billion has some collection potential, and
is at risk.[Footnote 9]
Increasing Compliance and Collection Staffing Has Been and Remains an
IRS Priority, but Declines Have Continued:
Since 2001, IRS's budget requests have made increasing its compliance
and collection staff one of several key priorities. For example, in its
2001 budget request IRS asked for funding for the Staffing Tax
Administration for Balance and Equity initiative, which was designed to
provide additional staff for examination, collection, and other
enforcement activities. However, as shown in figures 4 and 5, staffing
in two key compliance and collection occupations were lower in 2002
than in 2000. This continues a general trend of declining staffing in
these occupations for a number of years.
Figure 4: Number of Revenue Agents, Fiscal Years 1996-2002:
[See PDF for image]
[End of figure]
Figure 5: Number of Revenue Officers, Fiscal Years 1996-2002:
[See PDF for image]
[End of figure]
The declines in compliance and collection staffing occurred for several
reasons, including increased workload and unbudgeted costs. In
September 2002, the Commissioner attributed the decline in compliance
staffing to increases in workload in other essential operations, such
as processing returns, issuing refunds, and answering taxpayer mail. In
the most recently completed fiscal year, 2002, IRS faced unbudgeted
cost increases, such as rent and pay increases, of about $106 million.
As a result, IRS had to delay hiring revenue agents and officers. IRS
noted in its 2002 budget request that any major negative changes in the
agency's financial posture, such as unbudgeted salary increases, will
have a negative effect on staffing levels.
Fully Realizing a Fiscal Year 2004 Staffing Increase May Be
Challenging:
For fiscal year 2004, IRS is requesting $10.4 billion, an increase of
5.3 percent over fiscal year 2003 requested levels, and 100,043 full-
time equivalents (FTE). Also, IRS's 2004 budget request is its second
in a row to propose increased spending for higher priority areas that
would be funded, in part, with internal savings redirected from other
areas. Specifically, IRS proposes to devote an additional $454 million
and 3,033 more FTEs to enhance programs, including compliance and some
customer service areas. As shown in figure 6, $166 million of the
enhancements would be funded from internal savings with the remainder
funded from the budget increase.
Figure 6: IRS's Proposed Funding for Program Enhancements:
[See PDF for image]
[End of figure]
We commend IRS for identifying savings to be reinvested in operations
to improve IRS performance. This approach implements a key principle of
IRS's long-term modernization effort. Under this approach, the
reengineering of IRS's work processes, much of which depends on
investments in computer modernization, would automate or eliminate
work, improve productivity, and free staff time that could then be
redirected to higher priority customer service and compliance
activities.
Some caution is appropriate, however, in considering whether the
additional FTEs will be realized. In addition to the potential that
some cost increases may not be funded as in prior years, revised
projections developed since the 2004 budget request was prepared raise
questions about IRS's ability to achieve all the savings projected and
shift resources to compliance as planned.
IRS has revised the savings associated with several reengineering
efforts identified in the 2004 budget request. Revisions this far in
advance of the start of the fiscal year are not a surprise. They do
indicate some uncertainty associated with the budget request's savings
projections.
For example, most significant reengineering efforts planned for fiscal
year 2004, in terms of FTEs and dollars to be saved, will not achieve
all of their projected savings because the efforts were based on
assumptions that will not be realized, according to IRS data and
officials. IRS's effort to improve the efficiency of compliance support
activities, the single most significant effort, depended partially on
IRS implementing individual compliance savings projects in 2003. This
effort was projected to save 394 FTEs and almost $26 million. However,
due in part to delays until 2004 to allow for additional testing, this
effort is now expected to save about 30 percent of the original
projections through the end of fiscal year 2004. IRS now projects that
the seven most significant efforts will save 1,073 FTEs and $60.5
million, down from original projections of 1,356 FTEs and
$77.7 million.
Reengineering efforts may not achieve all of their savings goals, in
part, because of the long time lag between when IRS begins developing
its budget request and when the fiscal year begins. As with most other
federal agencies, IRS usually begins formulating its budget request
about 18 months before the start of the fiscal year and about 10 months
before the President submits his budget to Congress. With planning
beginning so far ahead of the budget's actual execution, inevitable
intervening events, such as delays in implementing computer systems,
make the assumptions upon which projections are based no longer
realistic.
In addition to lower current estimates of the potential savings from
the seven most significant reengineering estimates, some of the other
reengineering efforts listed in the 2004 budget request are not well
defined. This raises questions about whether they will achieve their
savings goals. For example, IRS still is reviewing its procedures to
identify ways to make tax return processing more efficient. Although
IRS projected this effort to save 203 FTEs and $6.9 million, it has not
yet identified the operational areas that will be reengineered. IRS
officials said that the projected savings are based on a 2 percent
efficiency increase, but they are currently determining how to achieve
that goal.
According to IRS budget officials, IRS uses its budget formulation
process to establish productivity goals, although the responsible
business units may not know specifically how savings will be achieved.
Officials said that this approach encourages innovation in meeting
performance goals while identifying ways to save FTEs and budget
dollars.
EIC Initiative Is a Substantial and Challenging Strategy to Target
Known Compliance Problems:
IRS's 2004 budget submission requests $100 million and 650 FTEs for a
new initiative to improve compliance in one area in which noncompliance
is known to be a concern: EIC. Although Treasury and IRS have made
progress in defining the scope and nature of the initiative, many
details about its implementation are still to be settled as planning
for and implementation of the initiative proceed simultaneously. IRS
hopes that this effort will reduce EIC noncompliance without
unnecessarily burdening or discouraging those who are eligible for and
claim EIC. Given its scope, potential effects on EIC claimants, and
planned rapid expansion, the success of the initiative will depend on
careful planning and close management attention as IRS implements the
initiative.
Begun in 1975, the EIC is a refundable tax credit available to certain
low-income, working taxpayers. Two stated long-term objectives of
Congress have been: 1) to offset the impact of Social Security taxes on
low-income individuals; and 2) to encourage these same individuals to
seek employment, rather than depend on welfare benefits. Researchers
have reported that the EIC has been a generally successful incentive-
based antipoverty program, as was intended by Congress.[Footnote 10]
For tax year 2001, about $31 billion was paid to about 19 million EIC
claimants.
However, in addition to its successes, the EIC program has historically
experienced high rates of noncompliance--including both overclaims and
underclaims of benefits. For over a decade we have reported on IRS's
efforts to reduce EIC noncompliance. Due to persistently high
noncompliance rates, we have identified the EIC program as a high-risk
area for IRS since 1995.[Footnote 11] An IRS study of 1985 tax returns
estimated that the EIC overclaim in that year rate was 39.1 percent.
The results of subsequent EIC compliance studies conducted by IRS are
shown in table 1.
Table 1: EIC Overclaim Rates for Selected Years:
Tax year: 1994; Overclaim rate estimates: Lower-bound: --; Overclaim
rate estimates: Upper-bound: 23.5.
Tax year: 1997; Overclaim rate estimates: Lower-bound: 23.8; Overclaim
rate estimates: Upper-bound: 25.6.
Tax year: 1999; Overclaim rate estimates: Lower-bound: 27.0; Overclaim
rate estimates: Upper-bound: 31.7.
Source: IRS reports.
Notes: All overclaim rates were adjusted by IRS to reflect dollars
recovered from ineligible recipients. For 1994 only a single estimate
was available. In 1997 and 1999, because not all individuals responded
to the audit contacts, IRS used certain assumptions to estimate an
overclaim rate range. The lower bound assumes that the overclaim rate
for the nonrespondents is the same as for the respondents, while the
upper bound assumes that all non-respondents are overclaims.
[End of table]
In 1997, Congress instructed IRS to improve EIC compliance through
expanded customer service and outreach, strengthened compliance, and
enhanced research efforts. For these efforts Congress authorized a 5-
year, EIC-specific appropriation of $716 million. Although the 5-year
period elapsed in fiscal year 2002, Congress appropriated $145 million
specifically for EIC compliance for fiscal year 2003. For fiscal year
2004, IRS is requesting $153 million for this appropriation; the $100
million request for the new EIC initiative is separate.
Early in 2002, when the results of IRS's most recent study of EIC
compliance for tax year 1999 were released, the Assistant Secretary of
the Treasury and the IRS Commissioner established a joint task force to
seek new approaches to reduce EIC noncompliance. The task force sought
to develop an approach to validate EIC claimants' eligibility before
refunds are made, while minimizing claimants' burden and any impact on
EIC's relatively high participation rate. Through this initiative,
administration of the EIC program would become more like that of a
social service program such as Food Stamps or Social Security
Disability, where proof of eligibility is required prior to receipt of
any benefit.
Based on its various studies of EIC noncompliance, IRS determined that
three specific areas account for a substantial portion of EIC
noncompliance. These three areas--qualifying child eligibility,
improper filing status, and income misreporting (also called
"underreporter")--account for nearly 70 percent of all EIC refund
errors, according to IRS. The joint Treasury/IRS task force designed an
initiative that would address each of these sources of EIC
noncompliance.
Filers that improperly claim qualified children represent the single
largest area of EIC overclaims, on a dollar basis. Under the proposed
initiative, IRS will attempt to verify all taxpayers' claims for EIC-
qualifying children under two criteria: a residency and a relationship
certification. IRS plans to use third-party databases and other means
to verify qualifying children for an estimated 80 percent of EIC
claimants. All other EIC claimants will be asked to provide additional
eligibility documentation prior to the filing season. Those who do not
respond and/or are unable to document their eligibility will have the
EIC portion of their returns frozen. If taxpayers do not provide
documentation before the filing season, IRS plans to require them to
provide it during or after the filing season. When and if they document
their eligibility, the EIC portion of their returns will be released.
Initially, beginning in the summer of 2003, IRS intends to select
45,000 EIC claimants whose qualifying child residency or relationship
requirements could not be verified from available databases. IRS plans
under its initiative to contact these taxpayers and give them the
opportunity to provide verifying documentation for the child (or
children) that is (are) claimed to qualify for the EIC. The two
components of establishing qualifying child eligibility--the
claimant's relationship to the child, and residency with the claimant
for more than 6 months--will be treated somewhat differently. Taxpayers
who establish their qualifying child relationship will not have to do
so in future years but all taxpayers will have to show annually that
the children lived with them for the required time. IRS expects to
expand the program in July 2004 by starting to contact approximately 2
million taxpayers; in another planned expansion in July 2005, IRS would
contact 2.5 million taxpayers.[Footnote 12]
The other two parts of this initiative will cover an additional 180,000
high-risk filers for tax year 2003--5,000 to verify their filing status
and 175,000 to verify their income. Criteria for selecting the 5,000
cases in the filing status category have not yet been determined. They
will be drawn from tax year 2003 cases. For the 175,000-case income
verification initiative, IRS will use document matching to identify EIC
filers who have a history of misreporting income in order to increase
(or receive) the EIC.[Footnote 13] Based on that history, these
taxpayers' returns are to be flagged when their 2003 EIC claims are
filed. Any EIC refund portion of each return is then to be frozen until
IRS can verify the taxpayers' income through document matching or audit
procedures in the fall of 2003. These filers will be identified out of
tax year 2002 and 2003 cases. Table 2 shows IRS's projections for
future casework in all three initiative areas.
Table 2: Proposed EIC Initiative Caseloads by Fiscal Year and
Initiative Type,
2004-08:
Thousands of filers.
Initiative: Qualifying child; Relationship
certification; Fiscal Year: 2004: 45; Fiscal Year: 2005: 2,000; Fiscal
Year: 2006: 1,500; Fiscal Year: 2007: 800; Fiscal Year: 2008: 100.
Initiative: Residency certification; Fiscal Year:
2004: ; --; Fiscal Year: 2005: 0; Fiscal Year: 2006: 1,000; Fiscal
Year: 2007: 1,000; Fiscal Year: 2008: 1,000.
Filing status; Fiscal Year: 2004: 5; Fiscal Year: 2005: 450; Fiscal
Year: 2006: 450; Fiscal Year: 2007: 450; Fiscal Year: 2008: 450.
Income reporting[A]; Fiscal Year: 2004: 175; Fiscal Year: 2005: 470;
Fiscal Year: 2006: 470; Fiscal Year: 2007: 470; Fiscal Year: 2008: 470.
Source: IRS documents.
Note: Projections are based on receiving an initiative-specific annual
appropriation of $100 million and estimates of how many cases IRS can
adequately work.
[A] Also known as the "underreporter" initiative.
[End of table]
Although the Treasury/IRS task force and now IRS have made progress in
defining the scope and nature of this initiative, many details about
its implementation are still to be settled. IRS expects to learn
lessons from initial sample cases it will work in 2003 that will be
incorporated into planned expansions of the effort later in 2003 and in
2004. IRS officials said that estimates of the number of new employees
that will be needed and their training requirements are evolving. For
example, although IRS's 2004 budget submission identifies 650 FTEs for
this initiative, current plans are for a much lower staffing level at
this point. In addition, cost and FTE estimates are based on historical
data that may not be directly comparable to the staffing and
technological demands of the initiative. Based on these estimates, of
the $100 million 2004 request, IRS has proposed budgeting just under
$55 million for direct casework in the three compliance areas. The
remaining $45 million is allocated to technology improvements and
management, development, and implementation costs related to the three
targeted compliance areas.
Fundamental to the precertification of qualifying children is the
development of clear forms that identify the specific types of
documentation IRS will accept to substantiate that a qualifying child
meets the relationship and residency tests for EIC. IRS is currently
working with others, like the Taxpayer Advocate, to develop these new
forms, which are to be used beginning this summer.
Recently, concerns have been expressed about IRS's intention to request
marriage certificates as proof of relationship to the qualifying child.
We have not looked at this specific issue. However, our 2002 report
noted that EIC forms and instructions that IRS used for similar
attempts to determine qualifying child eligibility could be confusing
to taxpayers and required documents that EIC claimants had difficulty
obtaining.[Footnote 14] When taxpayers have been disallowed the EIC
through an IRS audit, they are required to substantiate their
qualification for the EIC--that is, "recertify"--before they can
receive the credit again. As part of this process, IRS's forms
indicated that EIC claimants could, for example, use medical records to
prove a child's residency with them. However, EIC claimants faced
difficulty in providing such records. Low-income working families are
less likely to have stable relationships with medical service providers
and their children are less likely to have routine medical care.
IRS officials said that they plan to pretest the proposed
precertification forms both to determine whether they are clear and
understandable to EIC claimants but also to determine whether the
claimants can provide the required information. This is a critical step
in implementing the initiative. We recently reported that IRS seldom
tests the new and revised individual tax forms and instructions.
[Footnote 15]
Ensuring consistent interpretation of documentation gathered in the new
initiative will also be important. In our 2002 report, we noted that
IRS examiners did not consistently assess documentation for qualifying
children. For example, we asked 21 examiners to examine five EIC
scenarios. The 21 examiners did not agree for any of the scenarios,
and, in some cases, the examiners reached widely varying judgments
about whether the evidence was sufficient to support an EIC
claim.[Footnote 16] In order to better ensure consistent and accurate
decisions based on documentation submitted, we recommended that IRS
provide training to its examiners.
Administering the EIC is not an easy task for IRS. IRS has to balance
its efforts to help ensure that all qualified persons claim the credit
with its efforts to protect the integrity of tax system and guard
against fraud and other forms of noncompliance associated with EIC.
This initiative is a substantial undertaking with a relatively
aggressive implementation schedule. Although it appears to be targeted
to address known compliance issues, its success will depend on careful
planning and close management attention. Any one of many challenges
could put the initiative at risk. These include whether, for instance,
the proposed new forms will result in evidence that IRS can use to
verify relationship and residency requirements. Further, IRS must
determine whether lessons from the first attempts to verify the
eligibility of relatively small numbers of EIC claimants can be learned
and incorporated before the substantial expansion of the initiative in
fiscal years 2004 and 2005.
Challenges Must Be Met if IRS Is to Successfully Use Private Collection
Agencies:
IRS's 2004 budget requests $2 million and legislative authorization for
use of private collection agencies (PCA)[Footnote 17] to assist IRS in
collecting certain types of delinquent tax debt. IRS proposes to fund
continuing use of PCAs from a to-be-established revolving fund that
would receive a portion of taxes collected through use of PCAs.
As with its EIC initiative, IRS has defined the parameters for its use
of PCAs, but many key details for implementing the initiative remain to
be resolved. These implementation details, such as identifying
delinquent debt cases suitable for PCAs to pursue and protecting
taxpayer rights, will be critical if the initiative is to succeed. If
the PCA initiative is authorized, IRS will need to put focused
management attention on planning and monitoring the implementation of
the PCA initiative to ensure proper handling of these issues.
As previously noted, IRS's inventory of delinquent debt is growing and
aging, with the gap between its workload and capacity to complete work
increasing. As a consequence, IRS has been deferring about one in three
new delinquency cases without pursuing any collection action. This
practice is contrary to the experience of Treasury and IRS, which
indicates that referring eligible debts for collection as early as
possible greatly enhances the success of collection efforts. The former
IRS Commissioner estimated in 2002 that it would take 5,450 FTEs and
$296.4 million for IRS to bridge the gap between its workload and
capacity to complete the collection casework.
To help bridge this gap, Treasury has proposed an initiative to reach
taxpayers to obtain payment on delinquent debt through the assistance
of PCAs. Under this initiative, IRS would give PCAs specific, limited
information on outstanding tax liabilities, such as types of tax,
amount of the outstanding liabilities, tax years affected, and prior
payments. Based on the information provided by the IRS, PCAs would then
be permitted to locate and contact taxpayers, requesting payment of
liabilities (i.e., tax, interest, or penalty) in full or in
installments (within 3 years, as specified by IRS). If a taxpayer's
last known address is incorrect, the PCAs would search public records
for the correct address. PCAs are not to be permitted to contact third
parties to locate taxpayers. PCAs would not be allowed to accept
payments; all payments must be made to IRS. PCAs would generally have
12 to 24 months to attempt collection. Afterwards, uncollected accounts
are to be redistributed to other PCAs for additional collection
efforts. Because PCAs would have no enforcement power, the initiative
would allow the IRS to focus its own enforcement resources on more
complex cases and issues.
Other procedural conditions under the proposal include requiring PCAs
to inform taxpayers of the availability of assistance from the Taxpayer
Advocate. Furthermore, PCAs would not be permitted to take any
enforcement action against a taxpayer, such as seizing assets to
satisfy the debt. To ensure that taxpayer rights and privacy would be
safeguarded, PCAs would be governed by the same rules by which IRS is
governed.
Initially, IRS plans to stagger implementation of the initiative. For
the first 6 months, IRS will place collection cases with no more than
five PCAs, with a total volume estimate not to exceed 50,000 cases per
month for the first 3 months. IRS will contract with additional PCAs at
a 6-month interval with an anticipated rate of 2.6 million total cases
annually by the time all agencies have been operational for 1 full
year. Assigned case inventory rates will depend on a number of factors,
including PCA performance, ability to manage new inventory, quality
control, volume of cases referred to IRS for review, and readiness of
IRS to supply cases. Based on this implementation framework, Treasury
has projected revenue estimates of $46 million in 2004, and $476
million from 2004 through 2008.
In order to implement the PCA initiative, IRS must ensure that it will
have the capacity to fulfill its responsibilities under the proposed
contracts and to oversee the PCAs. Further, it must make some difficult
design decisions. One significant capacity issue concerns whether IRS
will be able to identify those delinquent debts with the highest
probability of resolution through PCA contacts. Earlier pilot efforts
to study use of PCAs in 1996 and 1997 were hindered, in part, because
IRS was unable to do this. For example, we reported that the numbers
and types of collection cases sent to PCAs during those pilots were
significantly different from those anticipated in the pilot program's
original design. This resulted in substantially fewer collection cases
than PCAs could productively work to make the effort cost-effective.
IRS realizes that identifying appropriate cases for referral to PCAs is
a key issue. While IRS proposes using "case selection analytics" to
identify appropriate cases, the analytical model has not been
developed.
Another IRS capacity issue relates to the cases that PCAs, for several
reasons, will refer back to IRS. For instance, under the proposed
arrangement, if a taxpayer was unable to fully pay the delinquent debt,
the case would be referred back to IRS. Some cases would then go to a
different PCA; therefore, the success of that PCA's efforts in these
cases would depend on how well IRS reprocesses the cases. Until some
experience is gained under the proposed program, it will be difficult
to reliably estimate the number of cases that will be referred back to
IRS and the number of resources it will need to devote to the cases.
Other IRS capacity issues concern, for instance, how many resources it
will take to administer the contracts and to oversee the PCAs'
performance. IRS expects to have up to 12 contractors, 2 of which would
be small businesses, and proposed procedures call for on-site visits
and some direct observation of PCAs' collection efforts. IRS would also
need to ensure PCAs' performance, such as having adequate procedures to
safeguard taxpayer information before and after the contracts are
awarded, and that it and the PCAs have secure computer systems to
manage the work flow.
How the PCAs will be compensated is a key design decision that must be
finalized. On the one hand, IRS needs to provide the PCAs an incentive
to be efficient in collecting the delinquent debts and on the other
hand, it must ensure that the incentive does not lead to inappropriate
performance pressure on PCA staff. IRS intends to make part of PCAs'
compensation dependent on other factors, such as quality of service,
taxpayer satisfaction, and case resolution, in addition to collection
results. Both the law and IRS policy prohibit IRS managers from using
records of tax enforcement results, such as dollars collected and taxes
assessed, to evaluate employee performance or set production goals. IRS
and Treasury report that existing taxpayer protections would be fully
preserved under the PCA initiative. Specifically, as with IRS
employees, PCA employees could not be evaluated based on tax
enforcement results. IRS is considering using a "balanced scorecard" to
measure contractors' performance, but has not proposed specifically how
this compensation balance will be struck.
Finally, although the revolving fund mechanism presents potential
advantages to IRS in better ensuring that it can pursue delinquent tax
debts, IRS has not done a cost analysis on implementing the PCA
initiative versus expanding the use of traditional IRS collection
activities. We have not seen any plans to do so in the future. Some IRS
officials believe that because IRS telephone collection staff have a
broader scope of authority (e.g., the ability to levy a bank account to
satisfy the debt) and greater experience with collecting delinquent
taxes, IRS telephone staff are likely to be more effective and cost-
efficient than PCAs. PCAs, however, may have advantages that IRS lacks.
A number of factors would need to be considered in doing a cost
analysis, and a comparison may not be possible without having some
experience in using PCAs to collect this type of debt.
Concluding Observations:
Although IRS has received increases in its budgets since fiscal year
2001 in part to increase staffing to enhance in its compliance and
collection programs, IRS has been unable to achieve the desired
staffing levels. Based on past experience and uncertainty regarding
some expected internal savings that would enable IRS to reallocate
staff to these programs, fiscal year 2004 staff increases might not
fully materialize. Today's hearing provides a useful venue for the
Subcommittee to explore these funding issues and how IRS should
prioritize its efforts.
IRS has defined the scope and nature of its proposed new initiatives to
address known sources of EIC noncompliance and to use private
collection agencies to assist in collecting certain delinquent taxes.
However, in both cases IRS faces significant challenges in moving
forward to successfully implement the proposals. In commenting on a GAO
report on IRS's National Research Program--IRS's ongoing effort to
measure the level of taxpayers' compliance while minimizing the burden
on taxpayers selected for the study--the former Commissioner said that
IRS would not compromise the quality of the program in order to meet
the program's target date. We believe this is a sound standard for
these efforts as well. Careful planning for and testing of key
implementation steps can help ensure the initiatives' success.
:
This completes my prepared statement. I would be pleased to respond to
any questions.
Contact and Acknowledgments:
For further information on this testimony, please contact Michael
Brostek at (202) 512-9110 or brostekm@gao.gov. Individuals making key
contributions to this testimony include Leon Green, Demian Moore, Neil
Pinney, and Tom Short.
(450200):
FOOTNOTES
[1] IRS and others sometimes refer to the four programs as enforcement
programs.
[2] The collection of delinquent taxes is also considered to be a
compliance program by IRS. For purposes of this testimony, it is
discussed separately.
[3] U.S. General Accounting Office, Tax Administration: Impact of
Compliance and Collection Program Declines on Taxpayers, GAO-02-674
(Washington, D.C.: May 22, 2002).
[4] Workload is the number of delinquent accounts assigned to field and
telephone collection. Work completed is the number of delinquent
accounts worked to closure, excluding accounts for which collection
work has been deferred.
[5] IRS considers employment tax compliance to be among the most
challenging issues for small business, since delinquent tax can rapidly
compound beyond the employer's ability to pay. See U.S. General
Accounting Office, Tax Administration: IRS's Efforts to Improve
Compliance with Employment Tax Requirements Should Be Evaluated, GAO-
02-92 (Washington, D.C.: Jan. 15, 2002).
[6] U.S. General Accounting Office, Tax Administration: Audit Trends
and Results for Individual Taxpayers, GAO/GGD-96-91 (Washington, D.C.:
Apr. 26, 1996); Tax Administration: IRS' Audit and Criminal Enforcement
Rates for Individual Taxpayers Across the Country, GAO/GGD-99-19
(Washington, D.C.: Dec. 23, 1998); IRS Audit Rates: Rate of Individual
Taxpayers Has Declined With the Effect on Compliance Unknown, GAO-01-
484 (Washington, D.C.: Apr. 25, 2001); Tax Administration: Use of
Nonaudit Contacts, GAO/GGD-00-7 (Washington, D.C.: Mar. 16, 2001); Tax
Administration: Impact of Compliance and Collection Program Declines on
Taxpayers, GAO-02-674 (Washington, D.C.: May 22, 2002); and Tax
Administration: IRS Should Continue to Expand Reporting on Its
Enforcement Efforts, GAO-03-378 (Washington, D.C.: Jan. 31, 2003).
[7] Internal Revenue Service, Report to the IRS Oversight Board:
Assessment of the IRS and the Tax System, September 2002.
[8] U.S. General Accounting Office, Major Management Challenges and
Program Risks: Department of the Treasury, GAO-03-109 (Washington,
D.C.: January 2003).
[9] Known unpaid taxes consist of (1) taxes due from taxpayers for
which IRS can support the existence of a receivable with a taxpayer
agreement or a favorable court ruling (federal taxes receivable), (2)
compliance assessments in which neither the taxpayer nor the court has
affirmed that the amounts are owed, and (3) write-offs, which are
unpaid assessments for which IRS does not expect collections due to
such factors as the taxpayer's death, bankruptcy, or insolvency. The
$112 billion only includes the first two categories.
[10] The Council of Economic Advisers, Good News for Low Income
Families: Expansions in the Earned Income Tax Credit and the Minimum
Wage, December, 1998. Congressional Research Service, The Earned Income
Tax Credit (EITC): An Overview, Updated report, March 19, 2003.
[11] Prior to 2001, EIC was part of a broader IRS Tax Filing Fraud
high-risk area. Beginning in 2001, the focus of that designation was
narrowed to EIC specifically. See U.S. General Accounting Office, High-
Risk Series: An Update, GAO-01-263 (Washington, D.C.: January 2001).
[12] According to IRS, planned expansions are estimates that depend on
its assessments of its capacity to handle and the results the proposed
45,000 filer initiative.
[13] IRS's automated underreporter system will be an important part of
the income verification initiative.
[14] U.S. General Accounting Office, Earned Income Credit:
Opportunities to Make Recertification Less Confusing and More
Consistent, GAO-02-449 (Washington, D.C.:
Apr. 25, 2002).
[15] U.S. General Accounting Office, Tax Administration: IRS Should
Reassess the Level of Resources for Testing Forms and Instructions,
GAO-03-486 (Washington, D.C.: Apr. 11, 2003).
[16] GAO-02-449.
[17] IRS is calling this initiative "Collection Contract Support."
