Ii- .--- It i t.td---Sh t t’s Gt*lltbral Actwurrl,illg ..__.....-___._,.I_. .-“‘.-..-“..-_-__..... ____..,.. Ol’l’iw --~ ._-_--. Ikport, Lo tGk%air.rnan, Cornmitt,ee on GAO 1,Iw Ihltiget,, I J.S. Senate ..-“..--.-I ---.- N~~~,t~~rIrlwr 1!1!~0 TAX -- ADMINISTRATION IRS’ Improved Estimates of Tax Examination Yield Need to Be Refined --- 3 142335 ____-,... -.ll-.--” -__.___- __..I.-.-. -- ..__--- GAo/G(;I)-!w-l I!) united state9 GAO General Accounting Office Washington, D.C. 20548 General Government Division B-240834 September6,199O The Honorable Jim Sasser Chairman, Committee on the Budget United States Senate Dear Mr. Chairman: The Internal RevenueService’s(IRS) budget for fiscal year 1991 includes several initiatives that are intended to generateadditional tax revenues by increasing or modifying IRS’ compliance efforts. Oneinitiative calls for increasing IRS’examination staff by adding 760 revenue agentswho audit the more complex tax returns and 290 support staff, According to IRS,the audits resulting from such a staff increasewill generate addi- tional audit revenuesof $1.1 billion by the end of fiscal year 1996. This report respondsto your request for information on the methodology IRS used to estimate those additional audit revenuesand its plans to track the results of the staffing increase-if the increaseis authorized by Congress. Results in Brief IRS revised its methodology for estimating audit yield following our 1988 report on problems with the methodology IRS was using at that time.’ IRS used its revised methodology to compute the $1.1 billion estimate associ- ated with the proposed fiscal year 1991 staffing increase.Although the revised methodology produces a more realistic expectation of the addi- tional revenuesto be derived from an increasein examination staff, we consider someof the assumptionsIRS used in applying the methodology to the proposed fiscal year 1991 staffing increaseto be overly opti- mistic. IRS assumedthat all the new staff would be on board by the beginning of the fiscal year and that a revised (and less costly) training program would be in place at that time-both of which have proven to be overly optimistic considering their current status. Delays in one or both of those events would delay realization of benefits from the staffing increase.IRS also assumedthat the influx of new staff would free up experiencedagentsto work on higher-yield cases,thus further increasing the audit revenuesgeneratedby increasedstaffing. We ques- tioned that assumption in our assessmentof IRS’ past methodology. IRS agreesthat it needsto further study that issue. ‘Tax Adminiitration: Difficulties in Accurately Ektimating Tax Examination Yield (GAO/ - 8. 119, Aug. 8,19@). Page 1 GAO/GGD9&119 TM Administration If the examination staffing increaseis authorized, IRSplans to monitor its impact. The reliability of that monitoring information will depend,in large part, on the validity of the baseline from which IRSbegins tracking results. BecauseIRS had not yet computed its baseline,we could not assessits validity. In our August 1988 report to the Chairman of the SenateBudget Com- Background mittee, we assessed(1) the methodology IRS was then using to estimate the additional revenuesassociatedwith an increasein examination staff and (2) IRS’ estimate of the amount of revenue actually generatedin fiscal year 1987 as a result of a congressionally authorized increasein examination staff that year. We raised several concernsabout IRS’ meth- odology for estimating the additional revenuesit expectedto realize from a staffing increaseand reported that IRS’ estimate of the increased revenuesit actually realized in fiscal year 1987 was overstated. The overstatement occurred primarily becauseIRS failed to account for any unrealized revenuesresulting from the use of experiencedrevenue agentsto train new staff. In responseto our concernsand those raised by the Department of the Treasury, the Office of Managementand Budget, and the Congressional Budget Office, IRS revised its estimating methodology.2It then used the revised methodology to estimate the additional revenuesassociatedwith the requested fiscal year 1991 increasein revenue agents. As agreedwith the Committee, our objectives were to provide informa- Objectives, Scope,and tion on (1) IRS’ methodology for estimating the yield associatedwith the Methodology increasein revenue agentsproposed for fiscal year 1991, including any available information relating to IRS’ plan to revise its revenue agent training program; and (2) IRS’ plans to track the results of that staffing increase. To develop information on IRS’ estimating methodology: . We reviewed past studies and reports on the estimating processand ana- lyzed statistical data on Examination’s plans and accomplishments. 21RSconsiders the new methodology to be an interim one while it develops more specific data on audit results that can be used to further improve its estimating assumptions. Page 2 GAO/GGD99-119 Tax Atidnistmtion B-249934 l We interviewed officials in the Office of Examination Planning and Researchand in IRS’ResearchDivision to obtain information on the esti- mating process. l We analyzed documentation provided by IRS to show how its estimating methodology works and to support the various assumptionsbehind that methodology. 9 We interviewed officials in the Office of the Assistant Commissioner (Examination) about changesbeing consideredin the training program for revenue agents. . We interviewed officials and group managersin the Examination Divi- sion at 1 of IRS’ 63 district offices (San Francisco)to obtain information on IRS’ estimating assumption relating to the allocation of audit resources.We choseSan Franciscobecauseit was one of the districts we had visited during our assessmentof IRS’ previous methodology and becausethe managersin that district were available to meet with us on short notice. We supplementedwhat we learned in San Francisco with information we had obtained from three other district offices (Atlanta, Chicago,and St, Louis) during an earlier assignmentfor the Committee. To obtain information on IRS’ plans for tracking the results of a fiscal year 1991 examination staffing increase,we interviewed officials in IRS’ Budget Division and in the Office of Examination Planning and Research,and we reviewed documentation describing the tracking methodology. Our audit work required us to use data generatedby IRS’management information systemsand by its computerized processfor estimating audit yield. We did not assessthe reliability of those data. However, we reviewed the data for reasonablenessand consistencyand attempted to resolve any discrepancies.We did our audit work between April and July 1990 and in accordancewith generally acceptedgovernment auditing standards. IRS provided written commentson a draft of this report. Those commentsare presented and evaluated beginning on page 14 and are included in appendix I. After we issued our August 1988 report, IRS reassessedits methodology IRS Has Improved Its for estimating the revenue to be generatedby an increasein examina- Methodology for tion staff. The reassessmentidentified several problems with the meth- Estimating Audit * Yield odology and led IRS to concludethat its estimating processproduced projections that “understate the time neededto realize direct benefits” Page 3 GAO/GGD-ml19 Tax Adminbtration B-240924 from staffing increases.3As a result of that reassessment,IRSrevised its estimating methodology. . The revised methodology, which IRS used to estimate audit yield associ- ated with the staffing increaseproposed for fiscal year 1991, provides a more realistic indicator of the revenue implications of such an increase than did IRS’ past methodology. Unlike past years when IRS estimated that the government would realize significant additional revenuesin the first year of a staffing increase,IRS’ new methodology has led it to con- clude that the proposed staffing increasefor fiscal year 1991 will result in decreasedrevenuesin the first year and will not start generating increasedrevenuesuntil fiscal year 1992. In revising its methodology, IRS addressedseveral concernsraised in our August 1988 report including those relating to (1) the productivity of new staff, (2) the audit revenuesthat go unrealized while experienced examination staff train new staff, and (3) IRS’ use of outdated informa- tion to determine how much of the additional tax liability recommended by examination staff as a result of their audits would eventually be collected. Productivity of New Staff Oneproblem with IRS’ past methodology was IRS’ assumption that the additional examination time made available by an increasein staff was generally applied to ongoing audits rather than to new audits. IRS’ revised methodology, however, assumesthat the additional time will be applied to new audits, which meansthat it will be longer before any audit results are realized. That change more accurately portrays how new staff are used and thus how soon audits worked on by new staff will be closed and how soon the government will realize revenuesfrom those audits. This changeis a major reason why IRS’ revised estimating methodology shows almost no additional taxes, penalties, and interest being collected in the first year of a staffing increasecomparedto the significant first- year collections shown by its previous methodology. As IRS noted in its November 1989 researchreport, for example, application of the revised methodology to a hypothetical increaseof 1,000 revenue agent staff years would show expected first-year collections of $1.1 million com- pared to the $321.4 million shown by IRS’ earlier methodology. 31RS reassessment wa8 documented in a research report entitled Evaluation of the IRS System of Projecting Enforcement Revenue (Publication 1601) published by IRS in November 1989. Page 4 GAO/GGD9O-119 Tax Admintstration Unrealized Audit A secondproblem with IRS’ previous methodology was its failure to rec- Revenues ognizethat the additional taxes, penalties, and interest generatedby new revenue agentshad to be offset by the taxes, penalties, and interest that went unrealized becauseexperiencedagents,who would otherwise be auditing returns, would have to train the new staff. IRS’ revised meth- odology recognizesthat fact. In an April 1990 report to the Committee, we commentedon the extent to which experiencedrevenue agentswere involved in training.about 1,100 new hires in five IRSdistrict offices between July 1, 1986, and June 30,1989, and the cost of that involvement in terms of unrealized audit revenues.4We concludedthat the government could end up investing about $980 million in unrealized revenuesto train those 1,100 agents. As part of the April 1990 report, we comparedour computation of unrealized audit revenueswith one that IRS had made using its revised estimating methodology. IRShad determined that the training associated with a hypothetical increaseof 1,000revenue agent staff years nation- wide would cost about $627 million in unrealized revenues.We attrib- uted the difference between IRS’ and our computations to differences in methodology. As noted in our April 1990 report, the appropriatenessof one methodology over another might dependon the number of new rev- enue agentsbeing hired and trained, We said that (1) our methodology seemedmore appropriate for the period coveredby our review, when IRS was training about 7,300 newly hired revenue agentsnationwide; and (2) IRS’ methodology might be more appropriate during periods when it is hiring, and thus training, a much smaller number of agents-which would be the caseif the proposed staffing increasefor fiscal year 1991 is authorized. 4Tax Administration: Potential Audit Revenues Lost While Training New Revenue Agents (GAO/ - -77, Apr. 6 1990). GF6so page 6 GAO/GGD4MMlB Tax Adminbtratlon E240834 Extent to Which In our August 1988 report, we noted that IRS used information from its RecommendedTaxes Are tracking of audits closedin 1972 to determine how much of the recom- mendedtax would be assessedand how much of the assessedamount Collected would eventually be collectedS6 We questioned whether that information was still valid. In revising its estimating methodology, IRS recognized that the 1972 audit results were no longer applicable and used data from the late 1980sto translate recommendationsinto eventual collections. Using the more recent data, IRS refined its approach by developing sepa- rate assessmentand collection rates for audits of individuals, small cor- porations (those with assetsof lessthan $250 million), and large corporations (those with assetsof $260 million or more). In the past, IRS used the samerates for all types of audits. IRS also reassessedthe timing of eventual collections and determined that it took much longer for those collections to comeinto the Treasury than IRS had assumedin its previous methodology, which would causethe amount of interest even- tually collected to increase. Tables 1 and 2 show how the assessmentand collection information used by IRS in its revised methodology compared to that used previously. As describedby IRS, the comparison in table 1 shows that eventual assessmentsof tax and penalties are much lower than previously esti- mated and that eventual collections of tax, penalties, and interest are about the sameas was previously estimated, with interest being “a much larger component of total receipts.“” Table 2 shows that the timing of collections is much slower, reflecting, according to IRS, “longer times in the examination, appeals/litigation and collection processes.” %S uses different terms to measure audit yield. “Recommended” is the amount of additional tax and penalties examination staff decide a taxpayer owes after auditing the taxpayer’s return. “Assessed” is the smount of tax and penalties IRS decides is due and payable from the taxpayer, which often differs from the recommended amount because of reductions resulting from the taxpayer’s appeal of the audit findings. “Collected” is the amount IRS receives in payment of the assessedamount, including any penalties and interest. ‘In computing its yield estimate for the fiical year 1991 staffing increase, IRS assumed an annual interest rate of 12 percent. According to IRS officials, they used 12 percent because it was the effec- tive rate when they developed the estimate, and they have no way of knowing what future rates wlll be. To the extent future rates deviate from 12 percent, IRS estimate will be over- or understated. The current rate, which will remain ln effect through September 30,1990, is 11 percent. Page 6 GAO/GGD99-119 Tax Administration Table 1: Comoarlron of Aa8errment and Collection Rates Used In IRS’ Past and Revised Estimatina Methoddoaieb As a percent of recommended tax and Denalties Revised method .Small Large Past method Individuals corporatione corporations Recommended tax and penalties 100.0 100.0 100.0 100.0 Assessed tax and penalties 71,2 67.2 56.9 44.5 Assessed tax, penalties, and interest 108.0 100.8 104.5 97.3 Collected tax, penalties, and interest 102.4 103.2 114.2 106.3 Source: IRS’ November 1989 research report (Publication 1501) --_-, Table 2; Comparison of Data on the Timing of Collectlonr Used in IRS’ Past and Revised Estimating Methodologies As a percent of recommended tax and Denalties Revised method Small Large Past method Individuals corporations corporations Year 1 (year of staffing increase) 76.5 3.9 0.0 0.0 Year 2 11.9 22.0 7.2 0.0 Year 3 4.3 28.5 35.1 18.3 Gar 4 3.2 18.5 24.1 25.7 iGar 5-k 6.5 30.3 47.8 62.3 Collected tax, oenalties. and interest 102.4 103.2 114.2 106.3 Source: IRS’ November 1989 research report (Publication 1501) After assessingthe documentation behind IRS’ revised methodology, it was clear to us that IRS had put forth considerableeffort to develop more current information on the rates at which recommendationsget assessedand assessmentsget collected, and the timing of those assess- ments and collections. IRS appearedto use the best data available in revising its methodology, but those data leave much to be desired due to limitations with IRS’ managementinformation systems,More specifi- cally, those systemsdo not provide data that are compatible across functional lines, thus preventing IRS from tracking audit casesthrough examination, appeals,and collection. Casetracking would provide pre- cise information on assessmentaJpdcollection rates and the length of time that transpires between examination and collection. To develop that information for its revised methodology, IRS relied on whatever rel- evant data it could obtain from various information systemsand the col- lective judgments of employeesit consideredknowledgeablein their respective operations. Page 7 GAO/GGMMl-I 19 Tax Adminbtration As discussedmore fully in our June 1990 report to the Committee’s Ranking Minority Member, IRS is developing a system that is intended to track the results of enforcement casesthrough all the relevant functions from start to final resolution.7As noted in IRS’ November 1989 research report, it will probably be several years before sufficient data are avail- able from that system for IRS to incorporate into its estimating methodology. IRS’ Expectations for Using its revised methodology (with someadjustment, as discussed later) IRS estimated that the examination staffing increaseproposed in the Proposed Fiscal the fiscal year 1991 budget would result in (1) decreasedaudit revenues Year 1991 Staffing of $18.2 million that year, (2) a modest increaseof $2.4 million in fiscal year 1992, and (3) sizeableincreasesranging from $300 million to $740 Increase Are Based on million in the next 13 years. IRS’ determination that appreciable reve- SomeQuestionable nues will not be realized in the short term from the increasedstaff is a Assumptions much more realistic assessmentthan would have been produced by IRS’ previous methodology. IRS’ ability to achieve even those reduced expec- tations, however, may be adversely affected by the fact that (1) new staff will not be coming on board as soon as assumed,(2) training pro- gram revisions that IRS assumedwould limit the amount of unrealized audit revenuesand increasethe productivity of new staff may not be in place when new staff start coming on board, and (3) IRS’assumption as to the kinds of returns it will be able to audit becauseof the additional examination staff years appears to be inconsistent with information we received from IRS’field offices. When Will New Revenue IRSdevelopedits estimate of the revenuesto be generatedby the fiscal Agents Comeon Board? year 1991 staffing increasein December1989. At that time, IRS assumed that the 760 new revenue agent positions would be filled at or near the beginning of the fiscal year. IRS officials said they basedthis assumption on the expectation that the budget/appropriations processfor fiscal year 1991 would be completed soon enough for IRS to bring the new staff on board by October 1. Considering recent history, that assumption seemsto have been overly optimistic. IRS’ appropriations for the last 3 fiscal years were enacted into law on December22, 1987; September22, 1988; and November 3, 1989, respectively. 7Tax Administration: IRS Needs More Reliable Information on Enforcement Revenues (GAO/ _QO_86, June 20,lOOO). Page 8 GAO/GGDsO-119 Tax Administration YM40834 Consideringthe current status of budget deliberations, IRS’ appropria- tion for fiscal year 1991 will probably not be enactedbefore the end of September 1990. By then, it may be too late for IRS to recruit college accounting students who are graduating before December1990.In the more competitive areasof the country, IRS may have to wait for the May 1991 graduating class. IRS’experiencewith respect to a revenue agent increaseauthorized for fiscal year 1987, although much larger than the increaseproposed for 1991, provides an indication of the difficulties that can confront IRSin trying to bring staff on board to fill newly authorized positions. For fiscal year 1987, IRS was authorized an increaseof about 1,600 revenue agents and was given advancehiring authority in July 1986. Even though IRS was able to start hiring about 3 months before the start of the fiscal year, it was only able to fill about half of the 1,600 authorized positions by January 1987 -6 months after it started hiring actions. A delay in bringing new agentson board in fiscal year 1991 will reduce the amount of additional revenuesIRS estimated would be generatedin the next 6 years. According to IRS officials, for example, if IRShad devel- oped its estimate on the assumption that the 760 positions would be filled by January 1, 1991, instead of October 1, 1990, its estimate of $1.1 billion in revenuesthrough fiscal year 1996 would decline to $963.3 million, When Will Changesto IRS’ As noted earlier, a major reasonwhy little, if any, additional revenue is Training Program Be generated during the first couple of years after an increasein examina- tion staff is the fact that potential audit revenuesgo unrealized when Implemented? experiencedrevenue agents,who would have been auditing returns, are used instead to train the new staff. When IRS revised its estimating methodology to start recognizingthe impact of those lost audit reve- nues, it becameapparent that the impact was considerable.As discussed in our April 1990 report, IRS concludedthat the training associatedwith an increaseof 1,000 revenue agent staff years would cost about $627 million in unrealized revenuesover 10 years. To reduce unrealized audit revenues,IRShas been considering somechangesto its training program. In estimating that the increasedexamination staffing proposed for fiscal year 1991 would lead to about $1.1 billion in additional revenuesover 6 years, IRSassumedthat two changesto the training program would be in place at the start of the fiscal year. Those two changesinvolve (1) using somecontract trainers in lieu of revenue agentsand (2) restructuring Page 9 GAO/GGD40-119 Tax Administration B-240894 the training program in an attempt to give new agentsthe training they need in a shorter time and thus increasethe time they spend auditing. In estimating the yield to be derived from the proposed fiscal year 1991 staffing increase,IRS assumedthat implementation of those changes would save about $93 million in training costsover 6 years, According to Examination officials, they plan to allow each of IRS’ seven regions to contract for its own instructors in fiscal year 1991, with the expectation of moving to a nationwide contract in fiscal year 1992. Dependingon each region’s ability to find acceptablecontract instruc- tors, the ratio of revenue agent instructors to contract instructors in any particular training class could vary from what has been the typical con- figuration of three agents and no contractors to one agent and two con- tractors (there will always be at least one agent in each class according to the officials). The hiring of fewer contract instructors would result in a lower yield than IRS had estimated in computing the revenuesto be derived from the fiscal year 1991 staffing increase.At that time, IRS assumeda classwould always involve one agent and two contract instructors. As of August 3, 1990, IRS’plans to use contract trainers seemedseveral months from implementation. An Examination official said that (1) IRScannot request bids on a contract until it knows what the training workload is going to be-something it will not know until its appropriation is enacted-and (2) oncebids are requested,it could be 2 to 3 months before contract award. New revenue agentsnow receive four phasesof training spread out over 26 months. Each phase comprisesseveral weeks of classroominstruc- tion followed by another several weeks of on-the-job training. The first two phasesdeal with tax laws that pertain to individual taxpayers; the third phase deals with laws pertaining to corporate taxpayers; and the fourth phase deals with, among other things, partnerships. IRS is consid- ering several changesto that training structure. According to an Exami- nation official, IRS is considering (1) reducing the number of training phasesfrom four to three by combining the last two; (2) reducing class- room training from a total of 20 weeks to about 16 weeks; (3) reducing on-the-job training from a total of 41 weeks to 19 weeks; and (4) expanding the length of time between phase 2 and new phase 3 from 26 weeks to 60 weeks, thus allowing trainees to spend more time auditing returns. This proposed restructuring goesbeyond what IRS assumedin preparing its $1.1 billion estimate and thus, if implemented, could cause IRS’estimate to be understated. IRS officials said that training time can be reduced without adversely affecting quality by doing such things as Page 10 GAO/GGD-90-119 Tax Admlnbtration E240924 eliminating redundancy between phasesand using lessformal settings, like workshops, to convey somematerial that had beencoveredin class. BecauseIRShad not begun awarding training contracts and because restructuring plans have not been finalized, it is clear that the training changeswill not be implemented by the start of the fiscal year, as IRS assumedin developing its estimate. There may be little impact, however, because,as discussedabove,new staff will not be coming on board by the first of the year. We have no basis for determining when these or other changesto the training program might be implemented, whether they will be on-line when newly authorized revenue agentsstart coming on board, and what their effect will be on training costsand audit revenues. How Will the Influx of Oneconcernwe had with IRS’ previous estimating methodology that Additional Examination remains a concernwith the revised methodology is IRS’ assumption that the increasedaudit time provided by the additional staff will be allo- Staff Affect the Workload cated amongnumerous tax c1asses,B including onesin which new rev- of Experienced Staff? enue agentsdo not typically work. In developing its estimate of the revenue to be derived from the proposed staffing increasefor fiscal year 1991, for example, IRSassumedthat the increaseof 760 revenue agent staff years would translate to about 284 additional staff years that it could devote to auditing returns, after allowing for time that would be charged to training and other nonaudit activities. It then assumedthat about 16 of those additional staff years would be devoted to auditing returns in individual tax classes,with the other 269 devoted to returns in more complex, higher-yield tax classes,such as returns filed by corporations. In explaining this allocation, IRS National Office officials said that as new agents-who generally work the less complex, low-yield individual returns-come into IRS,experiencedrevenue agentscan move into more complex, higher-yield tax classes.It is IRS’position, therefore, that it is appropriate to attribute a portion of the yield from those higher-yield classesto the increasedstaff. TheseNational Office officials said that although they believe this movement of experiencedstaff occurs,they do not have empirical data to support the assumption. 8A tax class is a groupingof returns on the basis of return type, such as individual or estate; source of income, such as farm or business; and level of income. Page 11 GAO/GGDIH)-119 Tax Administration B-240924 District office managersand officials we talked with had a different per- ception. Managersof revenue agents and Examination officials in IRS’ San Francisco District Office and Examination officials in the Atlanta, Chicago,and St. Louis District Offices said that experiencedrevenue agents do not audit the type of low-complexity returns assignedto first- year trainees. They said that the low-complexity returns are usually examined by tax auditors (IRSemployeeswho audit less complex tax returns than those audited by revenue agents).The managerssaid that were it not for the trainees, those low-complexity returns would not be audited by their groups of experiencedagents.The district officials also said that it takes about 2 years from the beginning of an examination staff expansion before they seean increasein the staff years used in the audits of the more complex, higher-yield tax classes.By this time, the new staff will have beentrained to audit the more complex, higher-yield returns and the experiencedrevenue agentswill have returned to auditing from their training assignments. If IRShad allocated all of the proposed fiscal year 1991 increasein exam- ination staff years to individual tax classesin the first year of the increase,its estimate of $1.1 billion in revenue through fiscal year 1996 would have declined to $668 million, The Reliability of IRS’ Onepositive step being taken by IRS with respect to the various revenue- generating initiatives proposed in its fiscal year 1991 budget is the Tracking of Fiscal development of methodologiesby which it can track the results actually Year 1991 Results Will achieved under each of those initiatives. Congress’budget deliberations would be enhancedif it had reliable information on the amount of rev- Depend on the enue generatedby the various initiatives. IRS could also use the informa- Validity of Its Starting tion to verify the reliability of its estimates. The methodology IRS plans Point to use to track the results associatedwith the increasein revenue agents seemsto be fairly straightforward. IRS plans to compare the number of revenue agent staff years and associatedyield that would have been achievedwithout the increase(referred to as the baseline) with the staff years and yield actually achieved-the difference being attributed to the increasedstaff. IRS used the samebasic methodology when it esti- mated the yield that had beengenerated in fiscal year 1987 as a result of the increasedexamination staff authorized for that year. We raised several concernswith IRS’ fiscal year 1987 estimate in our August 1988 report, including the fact that IRS had, in our opinion, overestimated yield by reducing the baseline against which results were compared. Page 12 GAO/GGD-99-119 Tax Administration Before the start of fiscal year 1987,IRS expectedthat the authorized staffing increasefor that year would raise its revenue agent staffing level by 1,618 staff years-from a baseof 14,227at the beginning of the year to 16,846by year’s end. In fact, however, IRS’ revenue agent staffing level rose to only 14,939staff years by the end of fiscal year 1987-an increaseof 712 years, or 906 years lessthan expected.If IRS had held its staffing baseconstant at 14,227staff years, its computation of additional yield would have beenpredicated on an increaseof 712 revenue agent staff years. Instead, as discussedmore fully in our August 1988 report, IRS decidedthat about 90 percent of the 906 unreal- ized staff years applied to the base.As a result, IRS (1) reduced its base staffing level from 14,227to 13,414;(2) determined that the 1,525 staff year difference between the adjusted base(13,414) and the end-of-year staffing level (14,939) representedthe increasedstaff authorized by Congress;and (3) used that increaseof 1,626years to compute the rev- enue effects of the authorized staffing increase. We recognizethat events, like the need to absorb a pay increaseor a managementdecision to divert staff from Examination to handle a staffing shortage in Taxpayer Service,can lead to reductions in Exami- nation’s basestaffing level during the fiscal year. Someof these reduc- tions may be necessarybecauseof factors, such as a hiring freeze caused by the need to absorb a pay increase,that are beyond IRS’ control. Other reductions, however, represent discretionary managementdecisionsto changestaff allocations. It is important that IRSdiscloseto Congressthe extent of and reasonsfor any erosion of the base.It doeslittle good, in our opinion, for Congress to approve additional staff with the intent of generating additional rev- enue if that benefit is eroded by reductions to the base.For Congressto properly assessthe effects of staffing increases,therefore, it needsto know how and why the basehas changed. Before the beginning of fiscal year 1991, IRS will be computing the base- line against which it will track the results of a fiscal year 1991 staffing increase.Until it doesand until it has specified under what circum- stances,if at all, it will adjust the baseline and how, if at all, it will reflect the impact of such adjustments in its tracking results, we have no basis for assessingthe methodology’s validity or for determining whether the tracking results will be more meaningful than the results reported for 1987. Page 18 GAO/GGMO-119 Tax Administration B.240834 IRS’revised methodology for estimating the yield from an increasein Conclusions examination staff is a significant improvement over the methodology IRS used in the past. It addressesmost of the concernsraised in our earlier assessmentof the past methodology and produces a much more realistic projection of what the government can expect as a result of the staffing increase.In applying that methodology to the proposed staffing increase for fiscal year 1991, however, IRS made assumptionsabout the hiring and training of new agentsthat have proven to be overly optimistic. Also, IRS needsto develop information to support its assumption that hiring new agentsallows IRS to assignmore experiencedagentsto more complex, high-yield cases.If empirical data do not bear this out, IRS’esti- mates should be revised to reflect only that revenue generatedfrom audits in the tax classestypically worked by new hires. IRSplans to monitor the results of the fiscal year 1991 staffing increase, assumingit is authorized. Reliable information on results will be valu- able not only to Congressin deliberating future proposed increasesbut also to IRS as a check on the validity of its estimating methodology. IRS will be establishing a baseline against which results will be monitored. Until then, we cannot begin to determine whether the monitoring will produce reliable information. To further improve its methodology for estimating the revenue to be Recommendationto derived from an increasein examination staff, IRSshould develop empir- the Cornmissionerof ical data to show whether the influx of new examination staff allows Internal Revenue more experiencedagentsto work higher-yield casesand in what time frame. The Commissionerof Internal Revenuecommentedon a draft of this Agency Comments and report by letter dated August 29, 1990, (seeapp. I). The Commissioner Our Evaluation agreedthat there are someareasin which IRS neededto fine tune its processfor estimating examination revenues.He specifically agreedthat IRS neededto study the extent to which the influx of new staff allows more experiencedstaff to do more complex, higher-yielding audits and the timing of any such impact. The Commissionersaid that such fine tuning would not materially changethe revenue estimate in the Presi- dent’s budget for fiscal year 1991, He noted that the revenue estimate in the President’s budget still appears achievable if Congressacts quickly to approve IRS’ appropriation and to limit the impact of sequestration. The Commissionerwent on to say that greater certainty in the budget processwould enable IRS to make commitments to June graduates, bring Page 14 GAOp3GDfJO.119 Tax Admhiatmtion B-2408&6 them on board timely, and scheduletraining in a way that maximizes productivity. We agreethat the soonerIRS’appropriation is enacted and the less IRSis affected by sequestration,the better IRS’ chancesof generating revenues. Even then, however, we believe that IRScould have a much harder time meeting its revenue estimate than indicated by the Commissioner.As noted earlier, for example, if empirical data do not support IRS’ assump- tion that the influx of new staff enablesexperiencedstaff to work higher-yield cases,IRS’ S-year estimate of $1.1 billion in revenuescould be reduced to as low as $668 million. In discussingthe portion of our report dealing with changesto the rev- enue agent training program, the Commissionernoted that cumbersome procurement rules and budget uncertainties affected IRS’ability to move ahead quickly with planned contract training. He also indicated that we were concernedabout the fact that IRS was changing its original con- tracting plan and might be using more revenue agents as instructors than was originally assumed.We have no basis for judging the relative merits of IRS’ original and revised plans. Our only purpose in mentioning the changewas to alert the reader that one of the assumptionson which the revenue estimate in the President’sbudget was basedhas been revised. The Commissioneralso agreedthat the reliability of IRS’ monitoring of the revenuesgeneratedby the staffing increasedependsto a great extent on the validity of the baseline.He emphasized,however, that the baseline(amount of revenue that would have beencollected absentthe staffing increase)can only be estimated. We agreethat the baseline can only be estimated. Our concernis with the estimate’s validity and with subsequentchangesto the baseline. As arranged with the Committee, unlessyou publicly announceits con- tents earlier, we plan no further distribution of this report until 2 days from the date of issuance.At that time, we will send copiesof this report to the Secretary of the Treasury, the Commissionerof Internal Revenue,and other interested parties. Page 16 GAO/GGDSMlS Tax Adminbtration r E240824 The major contributors to this report are listed in appendix II, Please contact me on 2756407 if you or your staff have any questions con- cerning the report. Sincerely yours, Jennie S. Stathis Director, Tax Policy and Administration Issues Page 16 GAO/GGD4Mb119 Tax Administration Page 17 GAO/GGD-90419 Tax Administration Contents Appendix I 20 Comments From the GAO Comment 24 Internal Revenue Service Appendix II 26 Major Contributors to This Report Tables Table 1: Comparisonof Assessmentand Collection Rates 7 Used in IRS’ Past and RevisedEstimating Methodologies Table 2: Comparison of Data on the Timing of Collections 7 Used in IRS’ Past and RevisedEstimating Methodologies Abbreviation IRS Internal RevenueService Page 18 GAO/GGDIw)-119 Tax Administration Page 19 GAO/GGD-90-119 Tax Administration Appendix I CommentsFrom the ZntermalRevenueService” Note: GAO comments supplementing those in the report text appear at the end of this appendix. DEPARTMENT OF THE TREASURY INTERNAL REVENUE SERVICE WASHINGTON, D.C. 20224 Mr. Richard L. Fogel Assistant Comptroller General United States General Accounting Office Washington, DC 20548 Dear Mr. Fogel: We have reviewed your draft report concerning IRS’s revised methodology for estimating examination yield. We were pleased to see that GAO agrees that we have made substantial improvements in our estimating methodology and that we are making progress in assuring that we are held accountable for our performance. We also agree that there are some areas in which we need to fine tune our estimating process, but believe that our estimates reflected in the President’s budget for Fiscal Year 1991 would not materially change because of these findings. Given this and other improvements in restructuring our training programs, our original estimates appear to be achievable if Congress acts quickly to approve our appropriations and to limit the impact of sequestration. It should also be noted that any substantial delay will postpone revenue anticipated for the second and subsequent years. Revenue estimates aside, we should not lose sight of the fact that what is most important is a long-term commitment to increase IRS resources. Also, the Examination initiative discussed in this report is only one part of our overall FY 1991 revenue initiative. 4ny discussion of enforcement revenue estimating must be put into this context so Congress will have the benefit of your advice when considering the important issues of raising revenue and funding this agency to collect that revenue. October -- 1 Entry on Gut,/ Date Unrealistic for New Agents IRS’ revenue estimate assumes that 750 new revenue agent positions would be filled at or near the beginning of the fiscal year. Although we did not base the estimate on the assumption that advance hiring would be authorized, we did assume that IRS’ appropriations would provide funding for this initiative as of October 1, 199C. Because the initiative assumed nat:onwide hiring :n our 63 districts and because we can take many recruitment steps in anticipation of actual hiring, it was reasonable to assume that we could hire 750 new revenue agents very quickly after approval by Congress. We continue to believe we could do that. Although first-year revenue effects may have to be adjusted to reflect any delays, second and later years would not be greatly affected if Congress acts quickly to approve our appropriations. Page 20 GAO/GGD-90419 Tax Administration . Ckmmemta From the Internal Revenue Ssrvice -2- Mr. Richard L. Fogel If IRS could rely on a process that delivered a budget timely without the threat of sequestration, we believe we would be able to deliver the revenue projected for the initiative. Greater certainty in the budget process would enable us to make commitments to June graduates, bring them on board timely, and schedule training in a way that maximizes productivity. The current “stop and go” budgeting process has a continued detrimental impact on our ability to hire, train and retain quality employees. Possible sequestration further jeopardizes planned new initiatives as well as current revenue processing activities. Chanqes to IRS’ Examination Trainina Proqram GAO also cites our planned improvements in training as another factor affecting potential revenue from the initiative. As noted, IRS initiated these improvements in part to maximize early revenue producing activities of trainees and to free up our more experienced revenue agents for more productive work. GAO agrees that these improvements will, when fully effected, go a long way toward optimizing potential revenue increases in the early years of a revenue initiative, but does not believe we will be ready to contract out training by the beginning of the fiscal year as our estimates assumed. While we agree that there will be a delay of as much as two to three months, we firmly believe that we will be ready with contract trainers as soon as new hires are on board. In addition, we believe that our planned restructuring of training programs will increase revenue producing activities from the initiatives even more than originally projected. GAO expressed concern that our original plan for contracting out training was being changed to use two rather than one revenue agent per training class. If true, this of course would increase opportunity costs by taking more agents from revenue producing work. Although analysis has indicated that we may use two revenue agents rather than one per class in some locations because of the difficulty of hiring outside instructors, we believe this change will only impact a few of the smaller locations and will not have a substantial impact on our revenue estimates. Further, we believe the restructuring improvements noted above may more than offset any potential effect of this change. Cumbersome procurement rules, coupled with budget uncertainties, do impact on our ability to move ahead quickly with planned contract training. However, if Congress were to approve our appropriations request and remove the threat of sequestration, we believe we would be able to hire and begin to Page 21 GAO/GGD9@119Tax Adminbtralion “, Appendix I Comments From the Internal Revenue Service -3- Mr. Richard L. Fogel train new employees for the initiative within two to three months. The ability to plan in advance for the long term would greatly aid us in knowing when we could hire and contract for instructors. Migration of Work Of continuing concern to GAO was our assumption that increased audit time provided by the additional staff would be allocated among numerous tax classes, with new hires freeing up experienced agents to do more complex and higher yielding examinations beginning in the first year (known as “migration”). See comment, While we do not believe that the period 1985 - 1989 gives a realistic picture of what could be expected from any new initiative, we agree to study the impact and timing of the migration when new hires are brought on board. As noted by GAO, we have already taken into account, in our estimates, the reduced opportunity costs created when we use experienced revenue agents to train new employees. For this reason, we believe that the effects noted by GAO for the periods 1985 - 1989 reflect factors that have already been taken into account in our estimates. We do, however, welcome GAO’s assistance in conducting further study. See comment. GAO also compares planned versus actual staffing for the same period. We believe that comparing planned versus actual staffing neither proves nor disproves migration in the first year. Exceeding or underrealizing planned staffing can be caused by various other factors including, but not limited to, delays in training, hiring freezes, and difficulties in recruitment. Reliability of the Baseline IRS agrees with GAO that the reliability of estimates of revenue generated by any initiative depends to a great extent on the validity of the baseline, i.e., we must accurately estimate the enforcement revenue that would have been collected in the absence of the initiative. We must reemphasize, however, that this can only be estimated; it cannot be “tracked.” The Assistant Commissioner (Finance)/Controller and the Assistant Commissioner (Examination) are working to formalize the method Page 22 GAO/GGD-99-119 Tax Administration . . Appendix I Comments From the Intemal Revenue Service -4- Mr. Richard L. Fogel for estimating what would have happened in the absence of the initiative. Thank you for the opportunity to provide our comments on this report. Best regards. Page 22 GAO/GGB9&119 Tax Administration Appendix I Commenta From the Internal Revenue Service The following is GAO’S comment on the Internal RevenueService’sletter dated August 29, 1990. 1. Thesereferencesare to data that were in the draft report but are not GAO Comment in the final report. Page 24 GAO/GGDW119 Tax Administration Appendix II Major Contributors to This Report David J. Attianese, Assistant Director, Tax Policy and Administration General Government Issues Division, Washington, D.C. -1 RoyceL. Baker, Evaluator-in-Charge Kmsas City Re@ona1 Shirley A. Franklin ,Evaluator Office (268460) Page26 GAo/GGIMO419 TaxAdminIstration ._ ..I_ ____._,.,_._ “.__. I_--..-_.- -..- ---.“.--... ._ “_ “-l,_ . . ..__ - ___ _. ._..” .,_ __l”_.“_.-.-_- __- Orclc~ring lrlf’ornlal iorl i I.S. (kttvritl Acwttttt ittg Of’fiw I’. 0. IhbX co 15 (;;lit h(brst)urg, MI) 20877 Ortt(~rs Itlily ;IlsO tW t>t;lccVt by calling (202) 275-624 I.
Tax Administration: IRS' Improved Estimates of Tax Examination Yield Need to Be Refined
Published by the Government Accountability Office on 1990-09-05.
Below is a raw (and likely hideous) rendition of the original report. (PDF)